The 2017 exploratory secenario

2017 will be the first year the Bank of England runs an ‘exploratory’ scenario alongside the annual cyclical scenario (ACS). The aim of the exploratory scenario, which will be conducted every other year, is to complement the ACS by probing the resilience of the system to risks that may not be neatly linked to the financial cycle.

The 2017 exploratory scenario will assess risks to, and arising from, bank profitability.

As the November 2016 Financial Stability Report notes, the FPC has judged that a prolonged period of low profitability could impact banks’ ability to recover from future shocks by generating internal capital or issuing new equity.  TheBank therefore intends that the first exploratory scenario will consider the impact of weak global supply growth, persistently low interest rates, and a continuation of declines in both world trade relative to GDP and cross-border banking activity. It will also consider the impact of other structural changes on the profitability of individual banks and the sector as a whole, including increased competitive pressure on major banks from smaller banks and non-bank businesses.

The focus of the test will be on the implications for banks’ business models, the economic impact of any actions they would take to ensure their viability and the implications for their future resilience. The test will have a seven-year horizon to capture these long-term trends. Throughout the test horizon, the prudential standards implemented for the UK financial system will be assumed to remain at least as robust as those currently planned.  Consistent with the focus on business models rather than detailed financial performance, the data collected from banks will be significantly less detailed than that collected for the annual cyclical scenario.

This scenario will not be a more severe test of banks’ capital positions than the annual cyclical scenario. The test will instead allow the Bank to examine the potential future resilience of the banking system to shocks and consider the actions banks might take to restore their profitability. This will include examining the implications of any material changes for the UK and global economies.

Source:  Stress testing the UK banking system: 2016 results