The U.K. banks will be subjected to tougher stress test scenarios this year. Further, while unveiling the 2017 hypothetical scenarios, the Bank of England (BoE) also announced “an additional exploratory scenario,” which will assess banks’ business models in stressed conditions.

All the major seven U.K. banks – Barclays plc (BCS Quick QuoteBCS - Free Report) , HSBC Holdings plc (HSBC Quick QuoteHSBC - Free Report) , Lloyds Banking Group plc (LYG Quick QuoteLYG - Free Report) , Nationwide Building Society, The Royal Bank of Scotland Group plc , Santander UK and Standard Chartered plc (SCBFF Quick QuoteSCBFF - Free Report) – will be part of both the tests.

Notably, cyclical stress testing will take place annually and the exploratory testing will occur once every two years.

Tougher Scenarios for Annual Stress Test

This is the fourth year of the BoE annual stress test. Last year, all the banks except Royal Bank of Scotland had cleared it.

The test helps in determining how banks will fare under another economic crisis and a slump in the markets. So the BoE has come up with hypothetical scenarios that will be taken into consideration while conducting the stress test.

The hypothetical setups in the BOE’s stress test include the Chinese economy declining 1.2% (from 0.5% decline scenario in 2016), global GDP contracting 2.4% and U.K. GDP falling 4.7%. Moreover, domestic unemployment rate of 9.5% and a rise in interest rates to 4% (a significant change from interest rate of zero at last year’s stress test) are among the other situations.

Further, the scenario assumes U.K. residential property prices plunging 33%, commercial property prices tumbling 40% and a fall in oil price to $24 per barrel.

What’s the Need for Biennial Exploratory Scenario (BES)?

This will be the first time that major U.K. banks will be tested under “exploratory scenario.” The BoE’s primary aim to conduct this test is to scrutinize banks’ strategic responses to a more challenging operating backdrop.

These are focused on banks’ business models and sustainability to long-term changes in financial and macroeconomic scenarios. The hypothetical scenarios under the BES include continued low interest rates at near 0%, decline in global trade, weak global growth, increased competition from smaller banks and persistent misconduct expenses.

The test will have a seven-year horizon to assess the trends. Notably, the BoE will be coming out with “aggregate results” rather than discussing bank-wise details.

Road Ahead

The results for the annual stress test will be out during fourth-quarter 2017. So, till that time it is wait and watch for banks.

Each bank has to be above the benchmark capital level. In case they fail, the regulators are expected to take actions that could include raising additional capital, and prevention of dividend and bonus payments.

With the banks taking measures to strengthen their financials and confront challenges, the stress test further helps regulators to check the banks’ progress in the same and avert another crisis. Such measures would serve to improve U.K.’s financial stability and aid the overall global economic recovery as well. Further, this will boost the lending capacity of banks, thereby bolstering their financial positions.

Among the banks mentioned above, Lloyds Banking, Standard Chartered and Royal Bank of Scotland carry a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 (Strong Buy) Rank stocks here.

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