Blackfriar: Could we face another taxpayer bank bailout?

That’s according to a new report by the Adam Smith Institute, which claims that the latest round of Bank of England stress tests conducted in 2018 drastically underestimated the vulnerability of the UK banking system.

The institute claims that UK banks are still highly leveraged and a major shock could cause the banking system to collapse.

With the UK heading towards a no-deal Brexit at full speed, that could provide just such a “major shock”.

The Adam Smith Institute said that if the Bank of England had carried out its tests using market valuations of bank capital and appropriately high pass standards, then all major UK banks would have failed.

Meanwhile the big five UK banks have issued over £34 of debt for every £1 of equity and the average leverage of these big five banks has increased from 27.8 in 2017 to 34.4 in 2018

The institute said the Bank of England’s stress tests are “worse than useless” because they offer false risk comfort that leaves the economy needlessly exposed.

Kevin Dowd, author of the report and professor of finance and economics at Durham University, said the Bank of England’s stress tests continue to greatly overstate the financial resilience of the UK banking system.

It’s very true that high bank leverage was a key factor in the severity of the financial crisis and British banks are still highly leveraged.

The institute said that market valuations of bank capital are more reliable than book valuations and they indicate that markets believe that banks are still carrying large hidden losses that are not reflected in book valuations or in the stress tests.

It said that if the markets don’t believe the Bank of England, why should anyone else?

The free market think tank argued that stress tests are compromised by conflicted objectives, an inadequate number of stress scenarios, low pass standards, reliance on unreliable metrics and questionable modelling.

It said that if the Bank of England had carried out its stress tests using market values and using more appropriate pass standards, then the banks’ true weakness would have been revealed.

Professor Dowd suggested that the stress test programme is so “severely compromised” that it should be scrapped.

“Instead, the Bank of England should focus on the reforms really needed to get the UK banking system on its feet – raising capital standards, shutting down zombie banks, establishing tighter corporate governance and reforming accounting standards,” he added.

He likened the stress tests to a cancer test that cannot detect cancer and said they demonstrate a financial resilience on the part of UK banks that simply isn’t there.

He claimed that another crisis is a matter of time and neither the UK banking system nor the Bank of England are remotely ready for it.

It’s true to say that we heard that everything was fine before the financial crisis 12 years ago and that resulted in hundreds of billions of pounds of taxpayer bailouts and economic and political effects that are still being felt today.

The shock of a no-deal Brexit could trigger the next UK recession. The signs are that we could already be heading for one.

Imagine the shock of that combined with another taxpayer bailout.