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BoE to run 2-track stress test, eyeing prolonged headwinds

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BoE to run 2-track stress test, eyeing prolonged headwinds

The Bank of England said March 27 that its 2017 stress test of six British banks and one building society will comprise two stress scenarios, one of which will incorporate a hypothetical rise in the central bank's key interest rate to up to 4%.

The BoE will run an additional, biennial exploratory scenario alongside its annual cyclical scenario. This exploratory scenario will examine what would happen to lenders if the headwinds they have experienced since the financial crisis persist or intensify, rather than abating in line with expectations for a medium-term recovery of profitability.

Banks will be asked to produce results under the first seven years of the scenario, with details for three further years provided to help this process. The exploratory scenario will not focus on capital adequacy, seeking to measure how "banks would meet regulatory requirements and build sustainable business models in such an environment."

Among other things, the exploratory test sees a cut to zero in the Bank of England's main interest rate during the first year of the scenario, and keeps it there for the rest of the timeline. Interest rates also fall to 0.25% in the U.S. and remain at negative 0.4% in the eurozone.

The scenario also includes a stagnation of global trade, a halving in annual productivity growth relative to 2011 to 2016 and a slowing of global GDP growth relative to projections. It will also seek to measure the impact of increased competition on banks' interest margins and include stressed projections for misconduct fines and other costs, such as those relating to cyber-risk and preventing future misconduct.

The annual cyclical scenario, meanwhile, will assess how Britain's biggest banks would cope under severe and synchronized British and global macroeconomic and financial market stress, as well as an independent stress of misconduct costs. Within the scenario, the peak-to-trough fall in global GDP amounts to 2.4%, compared to a fall of 1.9% in the 2016 stress test, while the assumed decline in U.K. GDP also increases to 4.7% from 4.3%.

The scenario also incorporates an inflation rate of 5% by 2018-end, a sudden increase in the rate of return demanded by investors for holding sterling-denominated assets and an associated fall in the pound and a rise in the BoE's bank rate to up to 4%. The 2016 test envisioned a rate cut to zero percent.

The annual cyclical scenario spans a five-year period.

Barclays Plc, HSBC Holdings Plc, Lloyds Banking Group Plc, Nationwide Building Society, Royal Bank of Scotland Group Plc, Santander UK Plc and Standard Chartered Plc are participating in the 2017 stress test, the results of which will be published during the fourth quarter.