RBS fails stress test from the Bank of England; announces revised capital plan

ATM cash machines outside a branch of the Royal Bank of Scotland in Edinburgh.
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ATM cash machines outside a branch of the Royal Bank of Scotland in Edinburgh.

The Royal Bank of Scotland (RBS) announced a revised capital plan on Wednesday as the results of the Bank of England's (BOE) latest round of stress tests on the U.K. banking system revealed it as the poorest performer of the seven lending institutions examined.

From a capital adequacy perspective, RBS, Barclays and Standard Chartered were the three banks which failed to surpass the complete set of hurdles tested by the Bank of England.

RBS' updated plan was approved by the Bank of England's Prudential Regulation Authority (PRA) on Tuesday evening ahead of Wednesday's announcement that the bank had failed to meet two of its key measures of financial strength.

These metrics are known as its common equity Tier 1 (CET1) capital rate and its Tier 1 leverage hurdle rate which calculate the buffers that banks keep for times of financial stress. Under the stress scenario these are tested before the conversion of AT1 debt. The latter is an instrument - hybrid bonds that combines debt and equity elements - which automatically converts to equity once the bank's buffer ratio falls below 7 percent.

Once the AT1 debt was converted under the stressed scenario, RBS did surpass the CET1 hurdle but still fell short of both the leverage hurdle and a third test - the newly introduced systemic reference point - which holds banks deemed to be systemically important from a global perspective to a higher standard.

RBS' relative weakness was largely due to its sensitivity to ongoing conduct fines, impairments and regulatory changes to risk-weighted asset requirements. The risk profile of its book – more weighted towards the worse performing unsecured, corporate and globally exposed loans than the better-performing domestically focused secured loans – also affected its stress test performance.

Commenting on the results, Ewen Stevenson, the chief financial officer at RBS, said the bank was committed to creating a stronger, simpler and safer bank for customers and shareholders.

"We have taken further important steps in 2016 to enhance our capital strength, but we recognize that we have more to do to restore the bank's stress resilience including resolving outstanding legacy issues," he said in a statement.


Barclays sufficiently strong

While Barclays passed its CET1 hurdle unaided, the tests indicate it would also require conversion of its AT1 debt in order to meet its systemic reference point. However, the report emphasized that the capital plan currently in place at Barclays - which involves proposed actions such as the sale of non-core assets - is viewed as sufficiently strong that it was not being asked to submit a revised plan.

Meanwhile, although Standard Chartered just edged past all of the hurdle rate tests, it failed to meet the Tier 1 minimum capital requirement.

However, the report again played down the significance of the miss, saying the bank had already taken a series of steps to strengthen its balance sheet during 2016 which were regarded as sufficient to allow it to continue without submitting a new capital plan.

HSBC, Lloyds Banking Group, Nationwide Building Society and Santander U.K. all passed every test.


The test's stress scenarios

The tests were based on the institutions' balance sheets as of the end of 2015, meaning they did not factor in a series of capital strengthening actions taken throughout this year.

Nor did they explicitly incorporate the effect of Brexit, however, the report emphasized that this third round of stress tests were significantly tougher than the two previous examinations.

This year's scenario assumed annual global GDP (gross domestic product) growth falling to -1.9 percent, annual Chinese GDP growth sliding to -0.5 percent and U.K. GDP slipping by 4.3 percent alongside a 4.5 percent leap in the domestic unemployment rate.

The scenario also assumes U.K. residential property prices dropping off by 31 percent and a 42 percent plummet for commercial property prices.

The BOE's report concludes that "the banking system is in aggregate capitalized to support the real economy in a severe, broad and synchronized stress scenario."

'No system-wide macroprudential actions required'

The Bank also noted that the aggregate low point results for both the CET1 and Tier 1 ratios were above those revealed in the 2014 and 2015 stress tests and that "no system-wide macroprudential actions on bank capital were required in response to the 2016 stress test."

The BOE also released its Financial Stability Report on Wednesday with its key message being that the biggest risks currently faced by the U.K. financial system are global in nature and have increased in the past six months.

Of particular note, the report drew attention to the rapid pace of China's credit expansion relative to its GDP growth, anticipated disruption from the Brexit process and the potential for contagion from other countries' banking systems - such as Italy's in light of the upcoming referendum.