UK banks face stress tests on impact of energy crisis defaults | Banking

The UK’s largest banks will be tested on their ability to withstand a rise in defaults linked to sky-high energy prices, as part of the Bank of England’s delayed health check of the financial industry.

The Guardian understands that Threadneedle Street has crafted a new crisis scenario that will feature a deep economic recession, punctuated by soaring energy bills that could make it harder for some borrowers – particularly businesses – to afford loan repayments.

It comes as UK businesses await details of Liz Truss’s £150bn energy bills bailout package, which the new prime minister last week pledged would temporarily cap sky-high bills for companies that might otherwise be forced to close.

This year’s stress-test scenario will also feature a drop in asset prices, a further jump in interest rates and soaring costs to cover misconduct. Any lenders deemed too weak to cover these eventualities could be forced to raise billions of pounds in capital to strengthen their finances.

The Prudential Regulation Authority, which is part of the Bank of England and responsible for making sure banks and insurers are financially stable, is preparing to release the details of its stress-test scenario in the coming weeks, having postponed the annual exercise because of the war in Ukraine.

The results from the UK’s largest banks – which include NatWest, Barclays, HSBC, Lloyds, Standard Chartered, the UK arm of Santander, Nationwide Building Society and Virgin Money UK – will be made public in summer 2023.

While the annual stress-test exercise usually features a severe economic downturn, this will be the first time that banks are forced to prove they can withstand the effects of an energy crisis. The central bank has previously tested lenders against worst-case scenarios linked to major events such as Brexit and the Covid-19 pandemic.

It follows similar efforts by the European Central Bank, which has reportedly asked lenders to analyse how gas shortages could affect their business customers and default rates. Bloomberg said the ECB was expecting responses from lenders by mid-September, with follow-up conversations due at the end of the month.

During their second-quarter results in July, the UK’s largest lenders broadly shrugged off concerns of potential defaults linked to weaker economic forecasts and soaring costs, noting that few vulnerable customers actually borrow from major high street banks.

However, energy bill forecasts have since soared, putting a large number of their business customers – which are more exposed to price fluctuations since they do not benefit from the UK’s energy cap for households – at risk.

While Truss has promised to freeze household energy bills at £2,500 over the next two years, the details of a similar scheme for businesses have yet to be released. The government has only confirmed that businesses will be offered “equivalent support” as part of a shorter six-month programme, although further assistance will be considered for “vulnerable industries”. A review will take place in three months.

Economists reckon the huge bailout scheme for households and businesses will reduce the severity of the recession due to hit this winter, reducing the number of corporate failures and giving consumers more spending power.

The Bank of England has run annual stress tests on the UK banking sector since 2013, as part of its response to the 2007 financial crisis. The tests are meant to identify potential weaknesses in the banking system that could put financial stability at risk, and determine whether individual banks can keep lending to households and businesses despite the additional stress.

This year’s test results will be released six months later than normal, with the central bank having postponed the exercise in March to give lenders some breathing space as they grappled with financial disruptions caused by the war in Ukraine.

The regulator has yet to raise any concerns about the health of the UK banking industry despite the mounting cost of living crisis. In July, its financial policy committee said lenders had “considerable capacity” to keep lending despite the deteriorating economic outlook.

However, the committee did warn that the war in Ukraine could have a knock-on effect on energy-hungry businesses, including in the transport and manufacturing sectors. It promised to monitor the sector for “further downside risks”.

The Bank of England declined to comment on the pending details of the stress-test scenario.

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