The Bank of England declined to comment on the ASI report “No Stress: The flaws in the Bank of England’s stress testing programme,” released yesterday. They did however point to evidence given by Bank of England official Alex Brazier to the Treasury Committee, in which he described the stress tests as “really tough”.
Well, the stress assumes that GDP growth falls to -3.2 percent before bouncing back, inflation rises to peak at a little over 6.5 percent, long-term gilts peak just below 6 percent and unemployment peaks at 12 percent.
This is not a particularly severe stress when judged historically or by contemporary experience in the parts of the Eurozone, where we have much larger falls in economic activity and much higher unemployment rates.
The impact on this supposedly severe test on the banking system is also very mild. The unweighted average of capital to risk-weighted assets falls from 10 percent to a low of 7.3 percent before bouncing back a bit, and there is a similarly mild dip in aggregate profits. One gets no sense of large losses on banks’ bond or interest-sensitive collateral and loan positions, and the Bank’s scenario is notable for the absence of any major institutional failure: the scenario omits the severe knock-on effects one would expect from a severe downturn.
This suggests to me that the modelling of the banks’ response to the external shocks assumed in the stress is, well, not particularly stressful.
One would like to stress that the whole point of a stress test is to actually stress.
Kevin Dowd is the author of our new publication 'No Stress', which you can read here