Study Notes

Stress Tests for Banks (Financial Economics)

Level:
AS, A-Level, IB
Board:
AQA, Edexcel, OCR, IB, Eduqas, WJEC

Last updated 29 Nov 2018

Stress tests assess commercial banks’ ability not just to withstand severe shocks, but also to maintain the supply of credit to the real economy under severe stress. The Bank of England conducts annual stress tests to check the resilience of the banking system. If and when a bank is found to have insufficient capital, then it must take steps to increase their capital reserves. Stress tests have become an important part of the policy designed to maintain general financial stability in the aftermath of the 2007-08 Global Financial Crisis.

2018 Stress Test

In the 2018 stress-test scenario:

  • UK GDP falls by 4.7%
  • UK unemployment rate rises to 9.5%
  • UK residential property prices fall by 33%
  • UK commercial real estate prices fall by 40%.
  • The scenario also includes a sudden loss of overseas investor appetite for UK assets, a 27% fall in the sterling exchange rate index and Bank Rate (monetary policy interest rate) rising to 4%.

The 2018 stress tests found that all UK commercial banks had sufficient capital to be able to withstand this barrage of (negative) external shocks.

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