UK lenders passed Bank’s stress tests – but no one should feel relaxed by the news | Nils Pratley

Terrific news: the banks aren’t about to collapse. The UK’s big lenders would continue to be “resilient”, says the Bank of England, even if the dark clouds over the economy turn into a prolonged thunderstorm. They have sufficient loss-absorbing capital to keep lending to households and businesses even in a “severe stress scenario”. For good measure, the governor Andrew Bailey made a sharp comment that banks shouldn’t use worries about resilience as an excuse not to pass on interest rate increases to savers.

To those who fret that the stressed scenario is insufficiently stressful, the Bank had a reasonable response. A projected stressed base rate of 6% (these tests were designed last September) may be close to today’s reality of 5%, but other inputs into the “severe but plausible” sketch still offer yards of headroom.

UK GDP has risen a fraction since September, versus a 5% fall in the tests; inflation almost certainly won’t average 11% for three years; and you won’t find a mainstream economist who thinks the unemployment rate, now 4%, will rise to a stressed projection of 8.5%. What’s more, the interaction between factors, including recessions abroad, also matters stress-wise, argued the Bank. Fair point.

Yet nobody could possibly read the test results, plus the accompanying financial stability report, and relax. For starters, the “mortgage timebomb” – the effect of borrowers gradually coming off fixed-rate deals – only looks more threatening when you see the probable detonation set out in graphical form.

Only half of mortgage accounts (about 4.5m) have yet to suffer increases in payments after rates started to rise in late 2021. A typical mortgage holder coming off a fixed-rate deal in the next six months will see higher monthly payments of £220. And almost 1m homeowners can expect to pay £500 more a month to cover mortgage payments by the end of 2026.

The Bank says the overall mortgage debt-servicing burden will still be below peaks recorded during the 2007–08 global financial crisis and the early 1990s recession, but it’s referring to aggregate tallies that include unmortgaged households. The point is the financial pain is concentrated and intense.

And for renters, the news sounds worse as buy-to-let landlords contemplate a hit to their profits, which will inevitably translate in many cases to attempts to hike up rents. Here’s the Bank’s remarkable statistic related to interest coverage ratios (ICRs), a measure of rental income relative to interest payments: if landlords were to absorb higher mortgage costs themselves (in other words, keep the rent unchanged), the share of buy-to-let mortgages with ICRs below 125% would increase from 3% at the end of 2022 to just over 40% by the end of 2025. Therein lie the fine margins of buy-to-let borrowing – and also a world of potential aggro between landlord and tenant.

Or, if you prefer your risks to be more big-picture, go to the section of the financial stability report that reminds readers that non-bank financial institutions – think pension funds, insurers, investment funds – have grown since 2007-08 to represent about half of UK financial sector assets.

The authorities have already suffered one heart attack when LDI (liability-driven investment) strategies blew up after the Truss/Kwarteng “mini-budget” last autumn. Now the Bank is worried about games of over-leverage being played by hedge funds building large positions in the US Treasury market and exposing themselves to sudden price moves.

“The sharp transition to higher interest rates and currently high volatility increases the likelihood that MBF [market-based finance] vulnerabilities crystallise and pose risks to financial stability,” says the report.

“There continues to be an urgent need to increase resilience in MBF globally,” it adds. The Bank has been issuing such warnings for ages. One of these days, it may matter.