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Pedestrians are silhouetted in front of the City of London financial district on March 11, 2020.

TOLGA AKMEN/AFP/Getty Images

Britain’s top banks and building societies are robust enough to keep lending if the economy were to shrink by 30 per cent in the new coronavirus pandemic, according to a stress test carried out by the Bank of England.

The stress test was based on an economic scenario published by the BoE in its Monetary Policy Report (MPR) on Thursday, in which it said Britain was on course for the biggest economic slump in more than 300 years.

Under the MPR scenario, Britain’s gross domestic product drops by almost 30 per cent in the second quarter compared with the fourth quarter of last year and recovers as lockdown restrictions are lifted.

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Britain has been in lockdown since mid-March and the government is expected to announce some easing of restrictions in the coming days.

The BoE’s pared down, “desktop” stress test showed that banks have the capital buffers to withstand even greater losses than those that result from the MPR scenario, the BoE said in its interim Financial Stability Report (FSR).

Core capital ratios would drop from 14.8 per cent at the end of 2019 to 11 per cent in the second year of the test scenario, still well above their minimum regulatory requirements, it said.

“Over all, in the desktop stress test based on the MPR scenario, banks incur total credit losses of just over £80-billion [$138.2-billion].”

Companies could face a cash-flow deficit of around £140-billion under the scenario, the FSR said.

But usable buffers of capital built up by banks are more than sufficient to absorb the losses under the MPR scenario and, with the support of the government’s lending guarantee schemes, would also be enough to help the corporate sector finance its cash-flow deficit, it said.

The BoE has already told banks they can tap £23-billion in their counter cyclical capital buffers that would support lending of up to £190-billion.

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On Thursday, the bank held off from further stimulus measures, but said it was ready to take more action to support the economy.

DASH FOR CASH

BoE deputy governor Jon Cunliffe said that if banks once more failed to provide support, as in the financial crisis 10 years ago, the overall economic outcome would be worse and lead to greater losses for banks.

“On the basis of the scenario and of the desktop stress test, the economic impact of banks failing to provide support to the economy could worsen their own capital positions by around a full percentage point,” Cunliffe said.

The BoE reinforced its encouragement for banks to tap capital and liquidity buffers that are above mandatory minimum requirements, in order to keep credit flowing.

Pillar 2A buffers cover particular risks at individual banks and the BoE said on Thursday they would now be set at a nominal amount in 2020 and 2021, instead of a percentage of total risk weighted assets, to alleviate “unwarranted pressure” on banks.

The BoE set out further ways to ease regulatory burdens so that banks can fully focus on helping businesses and households.

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The BoE’s Financial Policy Committee said it was postponing the launch of a climate change-related stress test of banks from the second half of this year until at least mid-2021.

The BoE said it has also paused work on its stress test of insurers, saying it won’t publish the results and will postpone the next test to 2022.

The core banking system, along with market infrastructure like clearing derivatives withstood turbulence and instability in financial markets in March when there was a “dash for cash” as investors responded to lockdowns, the BoE said.

But the market moves brought back into “sharp focus” a number of vulnerabilities in the non-bank sector, Cunliffe said in a reference to open ended funds, some of which had to be suspended.

“The underlying issues in the non-bank sector will need to be addressed in due course,” Cunliffe said.

Market volatility also underscored why the Libor interest rate benchmark needs to be scrapped by the end of 2021, the BoE said.

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