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Bank of England restricts 'stress tests' to largest UK retail banks

Britain's smaller lenders and British units of foreign investment banks will escape the Bank of England's annual 'stress tests' of their resilience to financial shocks, the central bank said on Wednesday.

The BoE said it preferred to maintain its focus on major banks which account for 80 percent of lending to Britain's economy, but left the door open to broaden the scope of its annual probes to include non-bank firms such as asset managers.

"The United Kingdom needs bank that can weather shocks without cutting lending to the real economy," BoE Governor Mark Carney said.

British taxpayers had to plough billions of pounds to prop up RBS and Lloyds Banking Group after the 2008 financial crisis, and lending to firms and households took years to recover, slowing economic growth.

On Tuesday, legislators challenged Carney over whether the BoE was softening regulation in response to political pressure after finance minister George Osborne reversed the burden of proof for misconduct by senior bank executives.

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Carney denied regulation was being watered down, and on Wednesday the BoE said the focus on the largest banks was intended to ensure the BoE's resources were focused on lenders which had the biggest effect on the economy.

Britain is seeking to boost competition in banking and new entrants to the market will breathe a sigh of relief as they already face a new surcharge on profits.

The BoE did its first sector-wide stress test last year, which looked at how losses a housing market crash would damage banks' reserves, prompting Royal Bank of Scotland to raise extra capital. The results of this year's test -- which will focus on emerging market risks -- is due on Dec. 1.

A man sits on a bench outside the Bank of England in London.
Ben Stansall | AFP | Getty Images
A man sits on a bench outside the Bank of England in London.

From next year each bank will be given an individual pass mark for the amount of capital it needs to hold at the end of the test, as opposed to the common hurdle in the tests so far.

This year all banks will have to show they still have a core capital buffer of 4.5 percent at the end of the test, but this hurdle is set to be at least six percent next year.

The BoE said it did not think there would be much benefit to conducting extensive probes of the British units of foreign investment banks, as their financial health depended on their parent companies, which the BoE cannot regulate.

Only banks with more than 50 billion pounds of retail deposits will be covered by the stress tests, which includes RBS, Lloyds, HSBC,Santander UK, Standard Chartered and Nationwide Building Society.

Once a year the BoE will come up with a scenario based on the credit cycle, which will get tougher when assets prices are most overvalued and credit conditions are weakest.

The BoE hopes that this will encourage banks to lend more prudently, so that they find it easier to pass the stress test.

Every two years, the BoE will hold a separate stress test to look at structural risks, which could include banks' exposure to currency pegs or industry-wide changes.

Stress tests for the 50 percent of Britain's financial sector which is not made up of banks are also on the agenda, though there is no precise timetable.

The BoE said the model it applied to banks would often not be appropriate. Many of the risks in non-banks are sector-wide -- for example, if a number of mutual funds tried to exit a single asset category at once -- rather than firm-specific.