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The UK’s top eight banks “would continue to be resilient” in an economic environment “much worse” than the one they face, and are well positioned to support households and businesses through a period of rising interest rates, the Bank of England said on Wednesday.

The verdict of the BoE’s latest stress tests on banks’ capacity to weather potential catastrophes came as bank officials warned that the wider financial sector faced risks from a “highly uncertain” economic outlook and a “challenging” environment for risk.

Andrew Bailey, BoE governor, said banks were in a strong financial position to pay more interest on customers’ savings. Rising UK interest rates have pushed up banks’ core profitability by boosting net interest margins — the difference between the interest banks charge on their loans and the rate they pay on deposits.

“One big message from this morning . . . is that the resilience of the banking system is not a constraint on banks managing their net interest margins and therefore managing the rates they pay to savers,” Bailey told reporters. “Banks can take the decisions they need to take on that front without having to restrict [their interest rates] for financial stability reasons. 

“It’s important that rates get passed through, it’s also important that we have competition in the banking system, which encourages banks to compete on savings rates,” Bailey added. 

The UK has been regularly stress testing banks since 2014 but has not failed a lender since 2016, when nationalised Royal Bank of Scotland was ordered to raise £2bn, while Barclays and Standard Chartered were called out for shortcomings.

The latest tests, which cover NatWest, HSBC, Barclays, StanChart, Lloyds, Santander, Nationwide and Virgin Money, were based on a scenario set out in September 2022, before a spate of US bank collapses and the demise of Credit Suisse.

“UK banks are in a strong position to support customers who are facing payment difficulties,” the BoE said. “This should mean lower defaults than in previous periods in which borrowers have been under pressure.”

The tests found that the banks would face aggregate loan losses of £125bn over the five year period from June 2022, leading to a fall in their common equity tier one ratios to 10.8 per cent from their current level of 14.2 per cent.

The common equity tier one ratio is a key measure of financial strength that shows a bank’s high quality capital relative to the risk of loans and other assets. The passing grade for the stress tests was a common equity tier one ratio of 6.9 per cent.

Barclays and Standard Chartered fell to the lowest levels during the stress tests, coming in at 8.5 per cent and 8.8 per cent respectively.

Some of the shocks the banks were tested against — including UK interest rates rising rapidly to 6 per cent before “being gradually reduced to under 3.5 per cent” by mid 2027 — are largely in line with how the economy is actually progressing. UK rates are at 5 per cent and not expected to fall below 4 per cent until at least the end of 2024.

UK banks say they have so far seen little evidence of rising arrears in loan books even as mortgage rates climb past the levels reached after the disastrous “mini” Budget of September 2022.

The BoE on Wednesday said that 1mn UK households were facing monthly mortgage payment increases of more than £500 by the end of 2026 because of higher interest rates, if they refinance their mortgages for the same fixed terms as their current loans.

Still, officials said that while UK households and businesses were facing higher debt costs, mortgage defaults in particular should be limited because debt burdens were “some way below” the historic peak in 2007 and banks have capacity to offer “forbearance” to borrowers in distress.

“Banks in the UK play a vital role in supporting our economy and these results provide further confidence that we are able to withstand a severe shock; keeping our customers’ money safe and continuing to lend, even when times are tough,” said NatWest chief financial officer Katie Murray.

The BoE also shared further details of the ‘lessons learned’ from the collapse of Silicon Valley Bank and its UK arm in March, including confirming that it is working with the Treasury on a revamp of its resolution regime for smaller banks.

Additional reporting by Jane Croft and Siddharth Venkataramakrishnan

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