Stress tests show impact would be ‘no worse’ than this year’s tests, which were at extreme of what might be expected
Mark Carney, the governor of the Bank of England, described the result of this year’s stress tests on seven major lenders as evidence they can withstand a disorderly Brexit.
Carney said the Bank had reached this judgment after considering a variety of factors, including the logistical impact faced by airlines and customs, as well as issues the City faces from processing complex derivatives transactions without a transition deal.
It also took account of the results of this year’s stress tests on the UK’s leading banks, which would lose £50bn collectively under the scenarios the Bank imposed.
Carney said a disorderly Brexit would have an impact that was “no worse” than this year’s tests which, while not explicitly modelling the impact of the UK’s exit from the EU, were at the extreme end of what might be expected.
So what was the economic scenario in the stress test?
UK GDP falls by 4.7%. This is smaller than the 6.3% peak-to-trough fall during the financial crisis nearly a decade ago. But the impact on unemployment is greater, with the rate reaching 9.5%, double the current level, and more than the 8.4% it reached during the recession after the banking crisis. Unemployment does reach the level of nearly 12%, as in the early 1980s.
The increase in unemployment, however, during the period of the stress tests is greater than after the 2008 crisis – rising from 5.2% at the end of 2007 to 8.4% in the last three months of 2011. In the stress scenario it increased by 4.7 percentage points.
Under the scenario, global GDP falls by 2.4%, which is greater than the 1.9% fall during the financial crisis.
When the scenario was published in March, interest rates were at 0.25% (although they were increased to 0.5% earlier this month). In the scenario, rates rise to 4% which the Bank pointed to is in contrast to the banking crisis when interest rates were cut by five percentage points from 5.5% at the start of March 2008 to 0.5% by March 2009.
The Bank of England factored in a record 33% fall in UK house prices during the period of the stress tests. During the banking crisis they fell 19%.
One of the major impacts of Brexit has been the fall in the pound which is down more than 10% since the referendum. It currently trades at $1.32. Under the scenario, the Bank of England asked banks to consider the impact of of the sterling-US dollar exchange rate hitting a low of $0.85.
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