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Bank of England's post-stress test plan to keep capital requirements stable

British banks' overall loss-absorbing capacity is set to remain unchanged despite the Bank of England raising the countercyclical buffer, now that the biggest lenders have passed the annual stress tests.

The BoE is raising the level of the U.K. countercyclical buffer — a rainy day fund that is built up in good economic times — to 2% from 1%. But it also said that in 2020 it would consult on proposals to reduce the minimum capital requirements in a way that leaves the overall loss-absorbing capacity — capital and bail-inable debt — in the banking system broadly unchanged.

"By shifting the balance of capital requirements from minimum requirements that should be maintained at all times towards buffers that can be drawn down as needed, these changes will mean banks are more able to absorb losses while maintaining lending to the real economy through the cycle," it said.

The central bank said the countercyclical buffer could be released if required, and if cut to zero percent from 2% it would enable banks to absorb up to £23 billion of losses which might otherwise lead them to restrict lending.

John Cronin, an analyst at Goodbody, said boosting the countercyclical buffer while offsetting the increase through a possible reduction in Pillar 2A capital requirements would prepare the banks for the introduction of the final Basel banking reforms due in 2022.

'Strengthening' resilience

"The Bank of England is actually strengthening the resilience of banks' capital positions by improving their capital flexibility while maintaining minimum capital requirements at, roughly, current levels. The Pillar 2A reductions that are expected to come through are, of course, a key mitigant/offset in the context of impending changes to capital requirements owing to the implementation of 'Basel IV,'" Cronin said.

Basel IV is the nickname for the completion of the Basel III requirements that limit the reduction in capital that can result from banks' use of an internal ratings-based approach. Critics suggest that the reforms would lead to an increase in capital for banks and therefore should be treated as a distinct round of reforms in their own right.

The 2019 "Armageddon" stress tests weighed banks on their ability to withstand a shock to the financial system greater than the financial crisis and incorporating the effect of a disorderly Brexit, including a 2.6% fall in world GDP and rise in the bank rate to 4%.

All of the major banks passed the stress tests, with their aggregate common equity Tier 1 capital ratio after the tests still running at more than twice its level before the financial crisis.

Indeed, at the end of the third quarter, banks' CET1 ratio was more than 3x higher than at the start of the crisis. The biggest U.K. banks also continue to hold more than £1 trillion of high-quality liquid assets, the BoE said.

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