UK banks screen below average – Goldman Sachs

Research Team at Goldman Sachs, suggests that the UK banks had a comparatively weak stress test recently, with a particular focus on Barclays and RBS.

Key Quotes

“Overall, we find that UK banks had a mixed set of results: on the one hand, Barclays and RBS fared poorly, having among the lowest stressed CET1 ratios and the biggest declines in stressed CET1 ratio respectively. However, HSBC and Lloyds remained resilient despite this year’s test being tougher.

The EBA’s test does not apply an explicit pass/fail hurdle; its key output is therefore a stressed capital ratio. To identify banks with the strongest capital positions, we apply progressively more demanding hurdle rates (calibrated at standard supervisory levels, market levels and finally levels that allow for capital return) to the EBA’s test results.

Amongst the UK banks, we make several key observations:

(1) Barclays screens as performing particularly poorly when our hurdles are applied, showing a capital shortfall of €1.1 bn compared to the supervisory threshold (of 5.5% plus G-SIB), increasing to €6.8 bn when a 100 bp management buffer is added. In our view, the four main drivers of this poor performance in the stress test are: (1) the G-SIB buffer; (2) a low starting CET 1 ratio; (3) the static balance sheet assumption; and (4) a litigation and conduct risk hit.

(2) RBS shows one of the largest declines in CET1 ratio, but remains above all thresholds: its CET1 ratio under the adverse scenario fell to 7.8%, a substantial decline from its end-2015 level of 15.5%. We believe a significant part of the decline can be attributed to litigation and conduct risk and in this context note that RBS has yet to settle both private-label RMBS and FHFA-related litigation (while most other banks have resolved their FHFA cases).

(3) Lloyds’ resilience improved, with a decline in the CET1 ratio of only 291 bp in the adverse scenario (vs. c.400 bp in the 2014 exercise).

(4) Similarly, HSBC’s stressed CET1 at 8.7% remained well over its 8.0% hurdle rate, and this is despite the result not giving any consideration to the (now completed) disposal of Brazil (HSBC estimates 65 bp CET1 accretive).

(5) Baseline scenario assumptions for the UK: We note that some of the main assumptions used in the baseline scenarios, such as UK and US real GDP growth forecasts, now appear quite optimistic following substantial downward revisions by our economists, in particular following the referendum outcome.

Hence, we caution reading too much into the strong results of LLOY and RBS under the baseline scenario, in which both show capital ratios of over 14% and consequently screen as clearing all hurdles in relation to excess capital return.

As previously, the Bank of England will consider the result of the EBA stress test alongside the results of the 2016 Bank of England stress test, results of which will be announced towards the end of the year.”