Bank of England Stress Test

“..the stress-test results and banks’ capital plans, taken together, indicated that the banking system would have the capacity to maintain its core functions in a stress scenario. Therefore, the FPC judged that no system-wide, macro prudential actions were needed in response to the stress test.”

My main concern with the stress tests is that the explanatory document came bereft of the underlying economic scenarios!   How far did GDP fall, for how long and what was the recovery like?  Did IRs stay at an elevated 4+ plus from current levels or did they fall?  I have not got a clue as this exercise seemed to focus on fairly extreme contractions in domestic property markets, higher interest rates and some assumptions re mortgage, personal debt and CRE defaults.

Beyond this I do have a couple of pointers:

The first the pros: the Bank of England looked at some sort of financial shock that resulted in currency depreciation and a rise in inflation that led to a 4% rise in bank rates.  This led to a rise in unemployment to 12%.  

Impairments on mortgage and other forms of personal debt seemed to be significant as did impairment for certain banks on commercial real estate: the modelling looked at significant impairment, high Loan to Value ratios and a large rise in arrears for the household mortgage market, but this probably conforms to the higher asset prices risks in the scenario.

Secondly the cons:

Was the scenario realistic?  A 4% rise in interest rates in response to strong inflationary risks suggests a strong consumer boom and or an associated financial crisis.   Is this rate rise realistic?

Con 1 is relevant given that the B of E seemed to feel that the rise in net interest income that resulted from the rise in rates would help offset to some extent the impairments on their loan books.  Is the net interest income assumption realistic?

The model appeared to be cut off mid crisis as the arrears rate on residential mortgages was at its highest in the 3rd year of the test and had yet to wane, yet bank profits recovered towards the end of the 3 year model period – see chart 7 page 16.  The model was sanguine about international debt defaults, in particular Asian debt.  There has been increasing concern over cross border lending to Asian and other markets of late, so we appear to be focussing on a primarily domestic crisis.

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