A severe economic shock would exhaust the Co-operative Bank’s capital and force Lloyds Banking Group and Royal Bank of Scotland to bolster their financial strength, the Bank of England has found after exposing the banking sector to tests designed to measure its resilience.

The central bank created a hypothetical scenario involving a deep recession, an unprecedented collapse in house prices and a sharp rise in interest rates and unemployment over a three-year period beginning at the end of 2013.

The results of the tests on eight lenders came as markets focused on the turmoil in Russia’s economy, and Threadneedle Street said next year its tests would focus more on risks in emerging markets.

The Co-op fared worst under the first annual stress tests, brought in as a response to the 2008 banking crisis. It was the only bank to be ordered to submit a revised plan after the Bank found its capital would be “exhausted” under the stressed scenario.

The Co-op bank – owned by the Co-operative Group until last year – had already warned it might fail the test. It was the only one to fall below the 4.5% minimum core tier one capital ratio – a key measure of financial strength – set by the Bank of England.

The central bank said its capital would fall into negative territory under the terms of the hypothetical tests, although its actual capital position is much stronger.

Niall Booker, brought in during last year’s crisis to run the Co-op bank, said it would now accelerate its plan to pull back from its Optimum portfolio of higher risk mortgages that were granted by Britannia before its merger with Co-op in 2009. About £5.5bn of the higher risk assets – 40% – are to be shed by 2018.

Booker insisted there would no fire sale, although the bank would now make losses into 2016 – a year longer than previously expected.

Bailed-out banks RBS and Lloyds were both close to the hurdle rate. RBS, 79% owned by the taxpayer, would have been required to submit new plans had it not already begun to raise its capital buffers at the end of 2013. “We recognise that there is still much work to be done to improve the resilience of our balance sheet,” said RBS finance director Ewen Stevenson.

Lloyds, which is 24% owned by the taxpayer, was not required to submit new plans and will find out in the new year if it is able to resume paying dividends to shareholders for the first time since the 2008 banking crisis.

António Horta-Osório, the boss of Lloyds, said the bank had increased its capital since the end of 2013.

The Bank of England governor, Mark Carney, said policymakers were reassured. “This was a demanding test. The results show that the core of the banking system is significantly more resilient, that it has the strength to continue to serve the real economy even in a severe stress, and that the growing confidence in the system is merited,” he said.

While the banking system was stronger than during the 2008 banking crisis, there were still other concerns.

“Recent misconduct and other operational failings have highlighted that rebuilding confidence in the banking system requires more than financial resilience,” the Bank said.

“That, and changes to banks’ business models in response to commercial and regulatory developments, make it important for banks to continue to enhance the effectiveness of their governance arrangements.”

HSBC, Barclays, Santander UK, Standard Chartered and the Nationwide building society were the five other institutions tested and were not found to have any capital inadequacies.

They were not required to submit new plans. HSBC and Standard Chartered may be the focus next year when the Bank of England puts more emphasis on global risks.

The Bank said that over the three-year test period, from the end of 2013 to the end of 2016, the eight lenders would have made £13bn of losses before making profits in the third year. Without the series of economic stresses, the lenders were projected to make £100bn of profits over the three years.

Impairment charges would rise by £70bn under the stress tests. Capital ratios were also severely affected, with system-wide ratios falling from 10% to 7.3%. Economists at Capital Economics said that was a higher ratio than had actually been achieved in 2011.

The Bank of England took into account actions that banks could have taken during the three-year period, which included cutting staff costs and dividends, and changes in lending patterns.

But banks were not allowed to reduce their lending to the economy and Samuel Tombs, senior UK economist at Capital Economics, said he expected the supply of credit to increase next year.

The Bank has stepped back from including more lenders in the tests next year and warned that the leverage ratio – another way of measuring financial strength – would become part of the test in the future.

Steven Hall, banking risk partner at KPMG, said this would prove tougher. “On the face of it, these results provide limited festive cheer and the Scrooges among us would note that if a 3% stressed leverage ratio had been set for this exercise, half of the banks would have failed with a cumulative balance sheet de-leveraging of more than £350bn required,” he said.

How worried should I be about Co-op Bank?



If you are of a nervous disposition, you probably moved your money from the troubled bank long ago. The bank’s PR machine is keen to point out that the latest stress test “makes no real difference to customers on a day-to-day basis”. Even though Co-op Bank would see its capital “exhausted” by the most severe test, it said it was based on December 2013 data and it has since engaged in a turnaround plan which has seen it raise new capital.

So it’s actually plain sailing ahead for Co-op Bank?



Not quite. It admits it still has some way to go, which essentially means disposing of about £5.5bn worth of assets by 2018. These will mostly be the “optimum” book of rather sub-optimal mortgages it acquired from its ill-fated takeover of Britannia building society. It also reckons it will not return to profitability until 2017.

Will its mortgage and savings rates get worse?



Not necessarily. The bank points to a recently-launched credit card deal that is among the best in the market and says it has a very competitive “switching” package for customers moving to the bank. Its core ethical principles remain in place, making it an attractive home for many customers. But while it remains under pressure to beef up its capital position, it is unlikely to be top of the best buy tables.

So I should stick with the Co-op?



The standard advice remains the same; don’t keep more than £85,000 in an account at the bank, as that is the maximum that the Financial Services Compensation Scheme will pay out in the event of a collapse.

Patrick Collinson