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Financial stress test: Banks would survive 'hard' Brexit

Britain's biggest lenders all passed Bank of England tests simulating financial crises.

The Bank of England.
The Bank of England. PA

The Bank of England has put the UK's banks through their latest annual health check and, for the first time, none has been required to strengthen their balance sheets.

The Bank modelled how the financial system would be affected an economic shock that was even worse than the financial crisis in 2008.

All seven of our biggest lenders passed. HSBC, Lloyds, Nationwide, Santander and Standard Chartered did do comfortably. RBS and Barclays did so by the narrowest of margins.

The Armageddon scenario the Bank modelled included a severe recession, a slide in the pound, the worst collapse in the housing market in history, soaring unemployment and a global economic slump.

The Bank of England concludes that the stress tests demonstrated not only that our banks are robust, but that all of them would continue lending money to households and businesses through the most disastrous of Brexit scenarios.

Hard Brexit could have rather devastating economic consequences but the good news is the Bank of England judges that - unlike in 2008 - our banks wouldn't be part of the problem.

The assessment is interesting in the context of the warnings the Bank has issued previously regarding the potential impact of Brexit on the financial system.

There are hundreds of different possible outcomes to the negotiations between the government and the European Union. The hope is that common sense will prevail, the concern is that it won't.

The governor of the Bank of England Mark Carney.
The governor of the Bank of England Mark Carney. PA

In a worst case scenario, if we were to suddenly crash out of the EU without a deal or any provision for a period of transition, then there is a high risk that the payments system would freeze and that markets would descend into chaos. Our banks are robust enough to survive such an outcome.

The Bank is repeating its hope that there will be a speedy agreement to address the potential disruption Brexit could cause, flagging the potential upheaval in the insurance and derivatives markets in particular.

There are risks for both sides in negotiations.

Without legislation to preserve continuity of cross-border insurance then 6 million policy holders in the UK and 30 million in the EU will find themselves in a position where their provider no longer has the right to collect premiums or pay claims.

The future validity of derivative contracts with nominal value of £26 trillion would also be in doubt. 90% of interest rate swaps are currently cleared in London. The Bank believes there simply isn't the time for companies on both sides of the English Channel to make alternative arrangements, even if they were happy to bear the increased costs.

The integrity of the Bank's stress tests will undoubtedly be challenged. In the past there has been criticism of the Bank of England's focus on the "book" value of the banks' assets rather than their "market" value.

Eminent voices - among them Sir John Vickers - have pointed out that the currently share-prices of some of the big banks suggests that investors believe their loans are worth considerably less than the banks believe.

How many banks would have failed had the Bank carried out the stress-tests based on the "market" value? The Bank of England won't say and dismisses the Vickers view as too pessimistic.

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