The results of the 2022/23 annual cyclical scenario (ACS) stress test show that the major UK banks are resilient to a severe stress scenario that incorporates persistently higher advanced economy inflation, increasing global interest rates, deep simultaneous recessions with materially higher unemployment in the UK and global economies, and sharp falls in asset prices.
Banks start the stress test with improved asset quality since the last cyclical stress test performed in 2019, following increases in house prices, a tightening in lending standards and changes in the composition of banks’ balance sheets since then. This dampens the negative effect of the macroeconomic shocks included in this scenario.
Net interest income increases as policy rates rise in response to higher inflation. This benefit is constrained by banks being required to assume an increasing share of deposits are interest bearing, and that the interest paid increases by more than recent experience.
As in previous stress tests, banks’ resilience relies in part on their ability in a stress to cut dividend payments, employee variable remuneration, and coupon payments on additional Tier 1 instruments, as well as other management actions taken in response to the stress. The Financial Policy Committee (FPC) judges it important for investors to be aware that banks would take such actions as necessary if such a stress were to materialise.
The results of the stress test support the FPC’s judgement that the UK banking system has the capacity to support households and businesses through a period of higher interest rates, even if economic conditions are substantially worse than expected.