The UK’s biggest lenders are strong enough to withstand a financial earthquake stronger than the one that rocked the City in 2008, the Bank of England’s annual stress test has found.

Britain’s seven biggest banks could keep lending even if UK national income slumped 4.7 per cent, unemployment surged to 9.2 per cent, and world GDP dropped 2.6 per cent, Threadneedle Street said.

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The test was particularly severe this year to reflect risks from the US-China trade war and tensions in Hong Kong. The BoE said that the global economy was particularly vulnerable and that “there are further risks of escalation”.

The Bank said that the lenders – among them Lloyds, HSBC and Barclays – would have to cut dividend payments, staff bonuses and coupon payment on bonds to be able to keep lending in a downturn.

“Investors should be aware that banks would make such cuts as necessary if a stress were to materialise,” the Bank said.

The BoE also announced it would increase the cushion banks must have to ensure they can keep lending during a financial crisis. It said lenders must increase their so-called countercyclical buffer – very high-quality capital – to two per cent of risk-weighted assets from the current level of one per cent.

This would let banks take a £23bn hit during a downturn without restricting lending, the BoE said. It added that it would reduce other capital requirements so the changes would be roughly neutral.

Despite giving the banking system an overall clean bill of health, Threadneedle Street sounded a few warnings. In particular, it flagged that lenders were making riskier corporate loans and told banks they need to speed up their transition away from the Libor lending rate.

Banks are making more loans to non-investment grade firms that are highly indebted, the Bank said, meaning losses would be higher in the event of a severe downturn. Nonetheless, the small number of riskier loans did not stop banks from passing the test.

It also highlighted that the Libor rate – which banks use to lend to each other for short periods – will cease to exist after 2021, posing problems for the banking sector.

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“Continued reliance of financial markets on Libor poses a risk to financial stability that can only be reduced through a transition to alternative risk-free rates,” the Bank’s report said.

To guard against higher levels of financial risks, the Bank’s Financial Policy Committee will raise the level of the so-called UK countercyclical buffer – the amount of very high-quality capital the banks have to hold – to two per cent from one per cent of risk-weighted assets.

