Severe but plausible: Carney lauds Brexit stress tests for central banks

Stress tests conducted by the central bank show Britain's financial system would still have more than adequate capital to maintain lending in the face of multiple headwinds, said Carney

UK banks are prepared to withstand more than just Brexit, according to Bank of England Governor Mark Carney.

Stress tests conducted by the central bank show Britain’s financial system would still have more than adequate capital to maintain lending in the face of multiple headwinds, Carney said in a speech in New York on Friday. The bank has been “preparing for the worst” outcome to the U.K.’s negotiations, including improving liquidity, building capital buffers and planning for disruption to cross-border derivative contracts.

“We judge that the UK banking system has the capacity to absorb not only the consequences of a no-deal, no-transition Brexit, but also the losses that could be associated with intensifying trade tensions, a further sharp tightening of financing conditions for emerging markets, and substantial additional misconduct costs,” he said.

Bank of England

Carney also reiterated his call for European Union officials to address financial risks related to Brexit. Echoing warnings made by the BOE’s Financial Policy Committee last week, he said that the bloc has only made “limited progress” thus far, and “timely action by EU authorities is needed to mitigate risks to financial stability, particularly those associated with derivative contracts and the transfer of personal data.”

Severe But Plausible
 

Stress tests conducted last year required banks to withstand, among other things, a 4.5 per cent drop in gross domestic product, house prices plunging by a third and unemployment at 9.5 per cent. The scenarios involved in the tests are “severe but plausible,” Carney said Friday.

Carney laid out a similar scenario to the U.K. Cabinet last month as part of ministers’ preparations for a no-deal Brexit. In a letter on Wednesday to Nicky Morgan, chair of the Treasury Committee, Carney said he was discussing hypothetical situations in the meeting, and they were “not predictions of what is most likely to happen, but rather estimates of worst-case scenarios however unlikely they may be.”

In a speech that mostly focused on regulation since the financial crisis a decade ago, he added his voice to those of the Federal Reserve, rating firms and commentators in underlining the concern caused by the rapid expansion of the leveraged loan market.

“Global leveraged lending is growing at rates -- and has reached a scale -- comparable to the subprime on the eve of the crisis,” he said.

He also warned that “the ethical drift which periodically undermines market integrity and impairs finance’s ability to function effectively” is a danger unless authorities act to prevent it.

With assistance by John Glover, Jeanna Smialek, and Ivan Levingston