(Bloomberg) -- The Bank of England may be worried about Brexit, but it's confident about the strength of the banks it regulates to weather any storm.
The U.K.'s seven largest lenders all passed the central bank's latest stress test, showing they're strong enough to continue lending even during a no-deal Brexit that could send the economy into a tailspin.
The central bank's stress test was even tougher than the dire “disorderly Brexit” scenario, which the BOE also released Wednesday. That analysis includes an 8 percent drop in economic output within a year, a 25 percent drop in the pound and a 30 percent plunge in house prices.
In the stress test, two lenders -- Barclays Plc and Lloyds Banking Group Plc -- triggered the conversion of some subordinated debt to equity to replenish their capital. Lloyds' exposure to U.K. housing and Barclays's large consumer focus make them more vulnerable to disruptions in the economy. No such conversion occurred for the other banks.
“The results are positive overall,” according to Samuel Lopez Briceno, a senior analyst at Vanguard Asset Services. However, investors in some risky bonds and equity could be “significantly hit,” he said, if lenders stopped coupon and dividend payments in a stressed scenario.
Read More: Carney says the BOE is ready for the worst
The BOE's Financial Policy Committee “reviewed a disorderly Brexit scenario, with no deal and no transition period, that leads to a severe economic shock,” the regulator said on Wednesday. The banking system is “strong enough to continue to serve U.K. households and businesses” even in a no-deal divorce, it said.
In addition to their capital strength, banks also have the liquidity needed to survive a major market disruption, the FPC said. At group level, they have more than 1 trillion pounds ($1.3 trillion) of high-quality liquid assets, and could withstand more than three months of stress in wholesale funding markets.
In addition to Barclays and Lloyds, the other lenders covered by the test are HSBC Holdings Plc, Nationwide Building Society, Royal Bank of Scotland Group Plc, Santander UK Group Holdings Plc and Standard Chartered Plc.
This year's stress test held banks to a new accounting standard that will force banks to make provisions for potential losses right after making a loan. But, the BOE used a transitional form of the rules, known as IFRS 9, softening the blow to their results.
In its Financial Stability Report, the FPC also:
- Maintained the U.K. counter-cyclical capital buffer requirement at 1 percent of risk-weighted assets;
- Kept up pressure on the EU to take action to prevent market turmoil in a disorderly Brexit;
- Found that U.K. banks' holdings of securitizations of leveraged loans are “very small.”
--With assistance from Viren Vaghela.
To contact the reporters on this story: Silla Brush in London at sbrush@bloomberg.net;Stefania Spezzati in London at sspezzati@bloomberg.net
To contact the editors responsible for this story: Ambereen Choudhury at achoudhury@bloomberg.net, ;Fergal O'Brien at fobrien@bloomberg.net, Keith Campbell
©2018 Bloomberg L.P.
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