The BoE will start an annual test for the top eight UK lenders like Barclays, RBS and HSBC in 2014 and in the next five years it will be broadened out to include the UK subsidiaries of International banks.

October  9, 2013 : In a path breaking initiative, the Bank of England will now have a yearly stress test of the U.K’s biggest banks, the BoE on Tuesday published a discussion paper setting out proposals for annual tests to ascertain whether the UK’s most important lenders have enough capital reserves to sustain a bout of market turmoil. The BoE, which will take comments on the paper until January, expects to introduce the tests by 2018. Britain’s Central Bank said it will start an annual test for the top eight UK lenders like Barclays, RBS and HSBC in 2014 and in the next five years it will be broadened out to include the UK subsidiaries of International banks. Medium sized British banks are likely to face a cut-down version of the test, and clearing houses could face their own health checks later on, the BoE said.

“Stress can provide a quantum leap in transparency and accountability,” BoE Deputy Governor, Paul Tucker said. The test will be mainly used to form supervisory approaches rather than just to identify any capital holes to plug.

“These new proposals should reinforce confidence in the financial system by letting regulators make judgements that balance systemic risk with the need to support growth,” the British Bankers’ Association said.

The bank said it planned to disclose the scenarios being tested and its outcomes, but is seeking feedback from the industry before confirming the framework. Probable stress scenarios would include a housing market crash, a recession, a spike in unemployment and its vulnerability to external shocks such as the Eurozone crisis etc. Since the global banking crisis in 2008, Britain’s banks have undergone several ad hoc stress tests. The broader approach to check the health of the system as a whole would include topping up capital levels, raising margin requirements on derivative contracts, curbing dividends and bonuses, forcing banks to discontinue risky business lines and changing management. According to the discussion paper released last week, the bank plans to use a twin approach to testing, with all banks facing a common test of stressed market scenarios and individual ones to look into their specific vulnerabilities.

Action on Errant Management

The discussion paper also revealed that it could consider “changing banks’ management” if capital planning or governance fell short of required standards. The announcement came as it emerged that senior bankers could face imprisonment up to seven years if mismanagement of their business led to its collapse, under a new “reckless misconduct” offence. The draft law was one of a series of amendments to the Banking Reform Bill that is expected to receive Royal assent early next year.

The Treasury said “Senior managers could be liable if they take a decision which leads to the failure of the bank, or fail to take steps available to them to prevent such a decision being taken. UK banks will also face the next stress tests by European Union Regulators next year, the results of which have typically been published bank-by-bank in the past.