Although the top banks in the U.K. would survive a severe economic crisis, hybrid bonds issued by Barclays PLC and Lloyds Banking Group PLC would be wiped out, according to the latest stress tests carried out by the Bank of England, the results of which were published Nov. 28.
The two major U.K. lenders would see their common equity Tier 1 ratio fall below the threshold of 7%, automatically triggering so-called bail-in clauses in the class of debt known as Additional Tier 1 bonds, or AT1s, meaning they would be converted to equity or simply wiped out in order to boost the bank’s reserves.
In the scenario envisioned by the Bank of England, such a conversion would see the two lenders' CET1 ratios increase to around 9.7%, according to the research.
"According to the specific contractual terms of banks’ AT1 instruments currently in issue, conversion is based on a definition of CET1 that excludes the benefits of transitional arrangements under IFRS 9," the Bank of England said, referring to the new accounting standard that took effect at the start of 2018.
The stress test imagined a multi-year crisis for the global economy, with U.K. GDP falling 4.7% in the first year and unemployment growing to 9.5%, while residential property prices fall by 33% and commercial property prices fall by 40%. Total bank asset impairment charges in this scenario would rise to £143 billion over five years, but due to about £1 trillion of high-quality liquid assets on their balance sheet and a credit line of £300 billion from the Bank of England, the firms would continue to lend through the period even as they are projected to be unable to access wholesale markets for three months.
Net losses would amount to £170 billion over the period. Banks would also incur £25 billion in misconduct charges, down from the £40 billion in the 2017 stress test scenario.
Apart from Barclays and Lloyds, HSBC Holdings PLC, Nationwide Building Society, Standard Chartered PLC, Royal Bank of Scotland Group PLC and Santander UK PLC were also put through the stress test.
At the close of trading in London, Barclays shares were down 0.93%, RBS fell 0.74% while HSBC was 0.51% lower. StanChart and Santander stocks were up slightly.
"Despite facing loss rates consistent with the global financial crisis, the major U.K. banks’ aggregate CET1 capital ratio after the stress test would still be twice its level before the crisis," the Bank said, adding that the test showed that the British banking system was "resilient to deep simultaneous recessions in the U.K. and global economies that are more severe overall than the global financial crisis."
A "disorderly, no-deal" Brexit, although causing GDP to fall by about 8% compared to the 4.7% in the stress test, would also not cause bank failures among the top players, according to the regulator, which released its projections for such an event on the same day. Alarmingly, the disorderly Brexit scenario published separately by the regulator would cause a "severe supply shock" to the U.K., which would be more damaging than the crisis of 2008, assuming there would be no transition period.
Representatives of the regulator insist the figures should not be interpreted as a forecast but merely as a potential outcome that assumes no corrective action by the government and no new trade deals being struck with other countries.
The U.K. Parliament is set to vote on December 11 on the withdrawal agreement between the government and the EU, but opposition to the terms is high among members of both the Conservative and the Labour party, as well as, crucially, the Democratic Unionist Party of Northern Ireland.
Meanwhile, the Bank of England said that the European Commission must urgently provide clarification to U.K. clearing houses about the legal treatment of euro-denominated contracts settled in London.
Not doing that would obligate clearers to set in motion contingency plans, moving the contracts from the U.K. to subsidiaries in continental Europe, at considerable cost to EU businesses. Although the Commission has said it would legislate to allow continuing euro clearing in London for a limited period after Brexit, it has not revealed any details about the initiative.
"Without greater clarity on the scope, conditions and timing of the prospective EU action, the contracts the EU members have cleared with U.K. CCPs would need to be closed out or transferred by March 2019 — a process that would need to begin in December 2018," the Bank of England said.