Global tariffs and recession: UK sets 2025 bank stress test
The Bank of England on Monday launched its 2025 capital stress test of the country's seven biggest financial institutions, which will include a rise in global tariffs, a 20% drop in world trade and a jump in UK inflation to 10%.
The results will be published in the fourth quarter on an aggregate basis and for the individual firms. The central bank said the results will be used to set capital buffers for financial institutions and the banking system, and to flag potential risks. The BoE plans to run the tests every two years.
The seven institutions are Barclays, HSBC, Lloyds Banking Group, NatWest, Santander UK, Standard Chartered and Nationwide Building Society, which together represent 75% of lending to the UK real economy.
The BoE said the test will involve a hypothetical stress scenario to see how firms would cope with three elements: a macroeconomic scenario; a financial markets and traded risk scenario; and a misconduct stress.
The hypothetical 20% drop in world trade is due to a projected fragmentation of trading relationships leading to shortages of production parts and a slowdown in transport, which sparks inflation. “In addition, major trading nations impose import tariffs,” the BoE said.
Other elements in the macroeconomic scenario include a 5% fall in UK GDP and a 2% fall in world GDP; a near doubling in UK unemployment to 8.5%; UK interest rates rising to 8%; and UK residential property prices falling 28%.
Another part of the scenario foresees an escalation of geopolitical tensions leading to a sharp increase in commodity and energy prices, with oil prices projected to double and gas prices more than quadrupling to levels last seen in 2022.
In financial markets under the stress scenario, there is a two-percentage-point rise in Gilt yields, with 10-year government bonds peaking at 6.4% in the UK and US. Investment-grade and high-yield corporate bond spreads widen to levels similar to those seen in the 2008 financial crisis, with UK IG spreads peaking at 500bp and high-yield spreads peaking at 2,300bp, and US IG spreads peaking at 580bp and high-yield spreads hitting 1,700bp.
Global equity prices fall, with the UK’s FTSE All-Share index dropping by 48% and the US S&P 500 tumbling 57%.
As uncertainty and risk aversion in financial markets increases in the scenario, Cboe's volatility index, or VIX, increases to 45.
There is also a traded risk scenario in the test, which takes into account a lack of liquidity of trading book positions for investment banks. The test will include the ability of banks to withstand the default of seven counterparties that would be vulnerable to the macroeconomic scenario.
The test will also ask banks to include misconduct costs that relate to known misconduct issues, and to provide projections for how much they could cost.
The scenarios in the test cover a five-year horizon from the start of 2025.