BoE stress tests ‘useless’, says Adam Smith Institute

The study by the Adam Smith Institute claims that so ineffective are the tests that British banks found by them to be robust would actually buckle under the strain of a major economic shock.

The testing regime was brought in by the BoE in 2014 to gauge the ability of UK banks to withstand severe financial shocks.

But the institute said the tests are like a “ridiculously easy exam with a ludicrously low pass rate”, which disguises the ability of UK banks to cope with an economic blow on the scale of the 2008 financial crisis.

The Adam Smith report comes shortly after the European Banking Authority (EBA) unveiled the results of its latest stress tests which claimed that although Royal Bank of Scotland would see the third biggest decline in capital levels among 51 banks across the EU in the event of a severe shock to the financial system, on the whole the capital position of banks across Europe has improved since the financial crash of 2008.

But the new report claims that the UK is “sailing blindly into a second global financial crisis” and that every single UK lender would currently fail “more rigorous” stress tests by the US Federal Reserve.

The institute has called on the stress tests to be scrapped in favour of forcing decision-makers to be personally liable for risks and pinpoints 13 flaws in the stress test.

Kevin Dowd, professor of finance and economics at Durham University, who wrote the report, said: “The purpose of the stresstesting programme should be to highlight the vulnerability of our banking system and the need to rebuild it.

“Instead, it has achieved the exact opposite, portraying a weak banking system as strong. This is like having a ship radar system that cannot detect an iceberg in plain view.

“As the EU banking system goes into a renewed crisis, the UK banking system is in no fit state to withstand the storm.

“Once contagion spreads from Italy to Germany and then to the UK, we will have a new banking crisis but on a much grander scale than 07-08.

“The Bank of England is asleep at the wheel again.”

Asked whether the recent Brexit vote will exacerbate the situation, he added: “I’m worried we are going into a new banking crisis which could be worse than the global financial crisis. The whole point of bank capital adequacy is to ensure the banks are resilient and they can withstand shocks without collapsing in front of us. The problem is the opportunity to rebuild the banks has been wasted. We are now entering a new period of uncertainty and shocks where the worry is we could simply have a new banking crisis on a grander scale.”