Stress testing failures at the Bank of England disguise chronic weakness

New report from the Adam Smith Institute lampoons Bank of England’s ‘worse than useless’ stress tests that disguise the chronic weakness of the UK banking system

  • Bank of England’s stress test ‘worse than useless’
  • Every single UK bank would fail the more rigorous stress tests of the Federal Reserve
  • UK sailing blindly into a second global financial crisis
  • Stress testing must be abolished and decision-makers made personally liable for risks

A new report released this morning from the Adam Smith Institute suggests that the UK banking system is still in poor financial shape and that the Bank of England’s stress tests merely disguise that reality.
The report, “No Stress II: the flaws in the Bank of England’s stress testing programme”, challenges the stress tests carried out by the Bank of England to assess the financial resilience of UK banks, and refutes their claim that major UK banks could withstand another big shock.
The report's release comes as Europe faces a renewed banking crisis. There is already a major crisis in Italy and mounting concerns about Deutsche Bank, the biggest bank in Europe and recently described by the International Monetary Fund as the most systemically dangerous bank in the world.

The UK banking system is not much stronger. Current Bank of England stress tests are like a ridiculously easy exam with a ludicrously low pass standard. If you increase the pass standard to something reasonable, like that used by the Federal Reserve, then every single major bank in the UK would fail.
The report indicates no less than 13 fatal flaws in the stress tests, most of which cannot be fixed. It argues that stress testing methodology is completely compromised: it purports to be able to identify bank vulnerabilities, but there has never been a single case where stress tests were able to identify vulnerabilities in advance and fix them accordingly.
This was seen in Iceland, Ireland, Cyprus and Greece - entire national banking systems signed off as sound by stress tests, only to collapse shortly afterwards.

The report’s author Kevin Dowd, professor of finance and economics at Durham University, said: 
"The purpose of the stress-testing programme should be to highlight the vulnerability of our banking system and the need to rebuild it. Instead, it has achieved the exact opposite, portraying a weak banking system as strong. This is like having a ship radar system that cannot detect an iceberg in plain view.

“As the EU banking system goes into a renewed crisis, the UK banking system is in no fit state to withstand the storm. Once contagion spreads from Italy to Germany and then to the UK, we will have a new banking crisis but on a much grander scale than ’07-‘08.
“The Bank of England is asleep at the wheel again, and we will be back to beleaguered banksters begging for bailouts – and the taxpayer will be ripped off yet again, but bigger this time."

Notes to editors:

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The report “No Stress II: the flaws in the Bank of England’s stress testing programme” will be live on the Adam Smith Institute website from 09:00 3rd August 2016 and can be accessed ahead of time here.

The Adam Smith Institute is a free market, libertarian think tank based in London. It advocates classically liberal public policies to create a richer, freer world.