Following an 18-month review of around 70 banks and building societies by the Prudential Regulation Authority, the Bank of England has contacted several small lenders warning them about stress test failings.
The names of the businesses remain undisclosed, and they are also considered non-systemic institutions, so should they be unable to recover from an economic shock, their failure should not impact the UK’s financial health.
This is in contrast to more notable lenders such as Barclays, HSBC, Lloyds, TSB, NatWest and the like, who are required to carry out stress tests every year.
The PRA director, Laura Wallis, addressed the issues in a letter entitled ‘UK Deposit Takers Supervision: 2024 priorities’, which highlighted the main concerns of the watchdog.
She writes: “Our review found that although many firms understand the basics of recovery planning, there are significant areas for improvement, most notably related to the development of recovery scenarios and the calculation of recovery capacity.”
The letter also highlights that “a number of firms did not use scenarios of sufficient severity, which will limit the effectiveness and value of the testing”.
Wallis adds: “Our review found that firms are not calculating their recovery capacity effectively, nor are they adequately showcasing it in an understandable and usable way.
“This reduces the accuracy and reliability of the recovery capacity calculations.”
The PRA explains that supervisory statement SS9/17 should be used as a guide to gain a better understanding about recovery capacity.
It also states that recovery capacity should be quantified with regards to Leverage Ratio, Common Equity Tier 1 (CET1) capital and Liquidity Coverage Ratio percentage points.
In closing, the body states that its “rules and expectations” relating to “solvent exit planning”, as introduced in the PRA’s new policy statement PS5/24, must be met by October 2025.
Throughout the second half of this year, the financial stability watchdog has said it will raise dialogue with firms and trade associations about its concerns.
The body also confirmed that stress testing will be raised as a topic for discussion at its June CEO conference.
