Bank of England’s stress tests are not gruelling enough, says report to mark 10 years since run on Northern Rock

The UK’s high street banks are an accident waiting to happen and could struggle in another financial crisis, according to a report published on Wednesday to mark the 10th anniversary of the run on Northern Rock.

The report criticises the annual health checks – stress tests – that have been conducted by the Bank of England since the crisis and concludes that the methodology used by Threadneedle Street is flawed and the tests not gruelling enough.

Queues started to form outside Northern Rock branches across the UK on 14 September 2007 after the BBC reported that the Newcastle-based lender had received emergency funding from the Bank of England. It was the first run on a high street bank in the UK since Overend & Gurney in the 1860s and after attempts to find a buyer failed, the bank was nationalised in February 2008.

Kevin Dowd, a professor of finance and economics at Durham University and a long-standing critic of the stress tests, said the Bank does not use the correct measures to assess the health of the banking system. Dowd is also a senior fellow at the Adam Smith Institute, a rightwing thinktank.

His analysis – which the Bank of England has previously rejected – focuses on the health check of the major lenders published last November . Those tests were based on a number of hypothetical scenarios including house prices falling and the global economy contracting by 1.9%. Royal Bank of Scotland failed the test and Barclays and Standard Chartered would both have struggled to cope.

Dowd argued that the scenarios were “hardly doomsday” and disputes the way banks’ capital strength is measured.

“The stress tests are about as useful as a cancer test that cannot detect cancer. They seek to demonstrate a financial resilience on the part of UK banks that simply isn’t there,” said Dowd in the report. “Our banking system is an accident waiting to happen.”

The Bank uses the value of assets as calculated by the banks rather than their value on the markets which, he argued, would give a more accurate assessment of their financial health.

The leverage of banks has fallen by about a third since 2006 on the first measure but, according to Dowd, has increased by a half on the second.

“It is disturbing that 10 years on from Northern Rock, the best measures of leverage – those based on market values – indicate that UK banks are even more leveraged than they were then,” said Dowd.

The Bank of England did not comment on the new report but the subject was the topic of a hearing of the Treasury select committee in January. Bank officials had said the amount of capital in the system in the crisis had been increased and defended the stress tests as being as tough as during the financial crisis. Some of Dowd’s calculations included double counting, officials said.

Dowd said he had met the Bank officials after that select committee meeting but did not disclose the details of their discussions.