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BoE discloses key elements of 2016 UK bank stress test

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BoE discloses key elements of 2016 UK bank stress test

The Bank ofEngland on March 29 set out the key elements of the 2016 stresstest for the U.K. banking sector, the first to be carried out under theregulator's revised framework.

Seven banks and building societies, representing 80% of theoutstanding stock lending to the real economy by Prudential RegulationAuthority-regulated banks, will be subject to the test. The BoE will use anannual cyclical scenario for the first time to assess risks associated withcredit, financial and other asset markets. The scenario will incorporate notonly domestic elements but also risks in relevant international markets to theextent that they are judged to be material to the British banking sector.

The adverse macroeconomic scenario for the stress testinvolves a synchronized global downturn in output growth, with global GDPgrowth bottoming out at the negative 1.9% level seen during the 2008 financialcrisis. China and Hong Kong are particularly affected under the scenario, inwhich U.K. GDP falls 4.3%, accompanied by a 4.5 percentage point rise inunemployment.

Oil prices bottom out at $20 per barrel under the scenario,interest rates for households and businesses increase, credit spreads on riskierassets such as corporate bonds rise sharply and property prices fall globally.Chinese and Hong Kong property prices see particularly pronounced falls, whilein the U.K., residential property prices fall 31% and commercial real estateprices by 42%.

In addition to the macroeconomic scenario, banks will alsobe tested under a traded risk scenario — principally designed to examine U.K.banks' investment banking operations to a severe financial market shock — and amisconduct risk scenario, under which banks are asked to provide stressedprojections for misconduct costs that have a low likelihood of being exceeded.

The hurdle rate framework under the new scenario requireseach bank to meet all of its minimum risk-based common equity Tier 1 capitalrequirements, which comprise both Pillar 1 and any uplift to that minimumcapital requirement set by the PRA through Pillar 2. As a result, there will nolonger be a common CET1 risk-weighted hurdle rate across all banks.

The results will also be assessed against a systemicreference point, which will be the sum of the hurdle rate and the phase-in pathof a lender's global systemically important bank buffer. Theresults are scheduled to be published in the fourth quarter.

The BoE noted that under the updated framework, the stressbeing tested against will generally be severe and broad, with a view toassessing the resilience of major British lenders to tail-risk events. From2017, an exploratory scenario will be introduced to the stress tests toinvestigate the banking system's resilience to risks that are considered asemerging threats to financial stability and individual lenders but might not be"neatly linked to the financial cycle."

The lenders subject to the stress test are , , , , Santander UKPlc, StandardChartered Plc and Nationwide Building Society.