The Bank of England on Wednesday announced its revised approach to stress testing the U.K. banking system over the next three years.
The new stress testing procedure will introduce an annual cyclical scenario that will link the severity of the test to the financial cycle, including domestic, global and market elements. “Its severity is likely to be greater in an upswing, for example when growth in credit is rapid or asset prices unsustainably high,” the bank says in a statement.
It will also incorporate an exploratory scenario covering risks unrelated to the financial cycle that may represent emerging or latent threats to financial stability or individual banks.
The stress test will apply to banks with total retail deposits greater than £50 billion ($101.4 billion), but will not include U.K. subsidiaries of foreign-owned investment banks at this point.
“The United Kingdom needs banks than can weather shocks without cutting lending to the real economy. Our first concurrent stress tests run in 2014 – centred on the housing market – gave us assurance that the banking sector as a whole was well-placed to withstand such a severe scenario. We have also recognized however the need for our approach to evolve,” says Mark Carney, governor of the Bank of England, in a statement.
“The Bank of England is taking steps to ensure we can assess a range of future risks from a number of different sources to inform our micro- and macro-prudential policy decisions. Our approach embodies a comprehensive and detailed approach, a desire to deepen and strengthen our analysis, and the flexibility to respond to changing risks,” he says.
The stress testing approach is expected to evolve further, the Bank of England says, and it will publish further information on its approach to stress testing beyond 2018.