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UK tests banks for house price collapse

Tuesday, April 29 14:06:40

Britain's lenders will have to show they hold enough capital to withstand a near 35 percent slump in house prices and a spike in interest rates to 4 percent, the Bank of England (BoE) said today.

The BoE's Prudential Regulation Authority (PRA) said eight of Britain's biggest banks and building societies will have to undergo the so-called stress test, in some cases on top of separate European Union tests also announced on Tuesday.

Factoring in a slump in housing prices coincides with concerns among economists that there is already a bubble in property prices in Britain's capital which is spreading to the rest of the country, a view the BoE has played down.

The results of Britain's test will be published after the EU test outcome has been made public in October, but before the end of the year.

Banks will have to show, in what will be an annual test, that they would still have a core capital ratio of equivalent to at least 4.5 percent of their risk-weighted assets if hit by a slump in house prices and higher interest rates.

"If a firm's capital ratio is projected to fall below the 4.5 percent core equity Tier 1 ratio in the stress, there is a strong presumption that the Prudential Regulation Authority will require the firm to take action to strengthen its capital position," the BoE said in a statement.

A bank may even be required to take action to boost its capital levels even if it ends the test at or above 4.5 percent.

The European Banking Authority, an EU watchdog, has set a pass mark of 5.5 percent, but the BoE said the UK threshold is based on full implementation of tougher global bank capital rules known as Basel III. The EBA test pass mark is based on partial application of the global rules.

"The criteria that they are testing look very sensible to me ... They do these stress tests to demonstrate some robustness in their approach, but the PRA's got a lot of discretion to say you do or don't need more capital," said analyst Gary Greenwood at brokerage Shore Capital.

Shares in the banks being tested generally rose further after the BoE published details of its stress test.

The test of theoretical shocks will cover a three-year period when interest rates would jump to nearly 4 percent and unemployment rises to 12 percent, the BoE said.

Sterling would lose nearly a third of its value in the first year of the test.

The BoE wants to move beyond a simple pass or fail test and instead obtain data to check on the quality and not just the quantity of capital banks are holding in order to make a judgement on how much is needed.

For Barclays, HSBC, Lloyds and Royal Bank of Scotland, the exercise will come on top of a common "stress test" 124 leading European Union banks will undergo in coming months.