THE Bank of England’s stress tests have branded “worse than useless” by a prominent independent think-tank, which warns the UK is “sailing blindly” into a second global financial crisis.
The testing regime, brought in by the BoE in 2014 to gauge the ability of UK banks to withstand severe financial shocks, is heavily criticised in a report by the Adam Smith Institute, published today. It identifies “13 fatal flaws” in the BoE tests and calls for the regime to be abolished, demanding it is replaced by enhanced accounting standards which allow analysts to clearly assess banks' capital strength.
Report author Kevin Dowd, professor of finance and economics at Durham University, likened the tests to a “very weak exam” which is easy for banks to pass. Rather than serving as a warning system, he said the tests instil what he terms “false risk comfort”.
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However Mr Dowd, who called for BoE governor Mark Carney to be dismissed, does not expect the Bank’s tests to be dismissed at any time soon. “Unfortunately there is no appetite for revising the stress tests,” he said. “The Bank of England is completely committed to them and they are very much the flavour of the month.
“You have to bear in mind that the Bank of England has been [supporting] a narrative along the lines that the banking system has been fixed, the banks are recapitalised, and everything is fine. One has to see the stress test agenda as part of a Bank of England narrative that provides what I would regard as false risk comfort.”
The Adam Smith report comes shortly after the European Banking Authority (EBA) unveiled the results of its latest stress tests. They suggested 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, but on the whole suggested that the capital position of banks across Europe has improved since the financial crash.
However, Mr Dowd believes that the EBA tests are “no more credible”. He said: “On the one hand they are saying the banking system is fine. On the other if you just read the news about [the banking crisis in] Italy you will see that they are not. There is a lot of worry about Deutsche Bank, and Deutsche Bank came out very well in the EBA stress test, comparatively. I don’t buy any of it.”
Mr Dowd added: “The number one message I’d put to you is that the methodology of stress testing has failed again, and again, and again and again. With these stress tests we had, for example, the Icelandic banking system signed off as sound, and it collapsed. Then the Irish banking system, then the Cypriot banking system, then the Greek banking system [collapsed].
“You are dealing with a methodology that has no track record to support it.”
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Asked to comment on RBS, Mr Dowd said the state-backed lender remained a “huge cause for concern”, stating that in spite of a huge injection of taxpayers’ money “it is still not fixed”. But he said the other major UK banks were are faring “little better”.
Mr Dowd, who suggests every UK bank would fail the more rigorous tests of America’s Federal Reserve, fears the system is heading for an even bigger crisis than the global crash of 2007-08.
Asked whether the Brexit vote will exacerbate the situation, he said: “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.”
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