BoE banking stress test ‘worse than useless’, think-tank warns

The Bank of England’s banking stress tests are highly unreliable and could be “worse than useless”, a report has warned.

Libertarian think-tank the Adam Smith Institute said the Bank’s assessment of how well funded institutions should be could provide “false comfort”.

Regular stress testing - checking banks and building societies have enough cash to weather market shocks - was introduced in 2014 as a way to assess the strength of the sector.

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These tests are “fatally flawed” because they use a single scenario test with a low pass rate, the think-tank claimed.

Banks must hold a minimum of 4.5 per cent ratio to risk-weighted assets, which is below those global regulations, it said.

The BoE’s system also pressures banks to use the same risk management practices, making them “blind to the same risks”, the Institute added.

Head of research Ben Southwood told The Yorkshire Post: “If you have one body telling all the banks how to do their risk management, which is the direction we’re going in, you get a uniformisation of banking balance sheets, of banking risk practices and so on.

“That means when a crisis does come, if it happens to be a chink in their armour, then everyone goes down.

“It’s uniformity and over-optimism in a very simple, focused test, as opposed to what we favour, which is a more diverse approach.

“It might mean sometimes banks are more likely to have small crashes, but are much less likely to have big crashes like the one we had before the last crisis.”

He added: “The problem is not so much that [BoE is] regulating badly, it’s just that it’s a hard thing to do.

“I can understand why they’ve taken this approach, but I think they should reconsider.”

The BoE declined to comment.

In March, it published new guidelines that outlined tests for credit, market and trading book risk, among others.