The Bank of England gave Britain's state-backed lenders a narrow pass in its debut annual stress tests on Tuesday, but warned that next year banks would face tougher checks of their capital strength and international exposure.
Lloyds and rival Royal Bank of Scotland scraped through a doomsday scenario of plummeting house prices and soaring unemployment after both took pre-emptive measures to boost their defenses against potential losses.
The Co-operative Bank, which nearly collapsed last year before being bailed out by bondholders, was the only bank to fail the test, which was tougher on lenders with high exposures to British mortgages, such as Lloyds and Nationwide.
Co-op Bank, whose core capital fell to minus 0.2 percent under the stresses, said it would not have to tap shareholders for additional capital but would probably not make a profit in the next three years as its works out a recovery plan with the Bank of England.
Although Lloyds' narrow pass raised questions about whether it can convince the regulator to allow it to pay a dividend for 2014, investors said both Lloyds and RBS had performed credibly in a test which simulated the impact of a property crash and rising interest rates.
"While the passes weren't great, they were passes... The test was deliberately harsh and what's key is they passed and we can move forward," said David Moss, head of European equities at F&C Investments.
Shares in Lloyds were up 0.6 percent at 0938 GMT (04:38 a.m. EST) while Royal Bank of Scotland shares were down 0.4 percent.
MORE RESILIENT
Britain decided to introduce annual stress tests of its banks in the wake of the 2007-09 financial crisis which required taxpayers to pump 66 billion pounds into RBS and Lloyds to keep them afloat.
"The results show that the core of the banking system is significantly more resilient (and) that it has the strength to continue to serve the real economy even in a severe stress," the governor of the Bank of England Mark Carney said.
This year's stress tests required banks to have a core capital ratio of 4.5 percent but from next year, the Bank of England said that it would also assess banks' leverage ratios, which reflects their level of indebtedness.
Regulators are increasingly focusing on leverage ratios amid widespread distrust of banks' own assessment of the riskiness of their assets. The leverage ratio removes assets' risk weighting.
Both Lloyds and Royal Bank of Scotland had leverage ratios below the current 3 percent requirement under the Bank of England's stressed scenario. Barclay's leverage ratio was 3 percent under the stress test.
From 2019 onwards, large UK banks will have to have a leverage ratio of 4.05 percent and that could be increased in boom times by an extra buffer of another 0.9 percent to cool lending.
The Bank of England confirmed on Tuesday that for now there is still no need for banks to hold boost buffers during booms.
NO LET UP
The Bank of England stress test added a number of additional layers on top of those applied by European regulators in an EU-wide test of 123 banks in October, including a rise in interest rates to 4 percent from 0.5 percent currently.
Under the stress scenario, Royal Bank of Scotland's core capital ratio fell to just 4.6 percent, a whisker shy of the 4.5 percent minimum required, before actions it had taken this year to shrink its balance sheet were taken into account.
Lloyds' core capital ratio was 5.0 percent before its actions were taken into account.
Royal Bank of Scotland, which is 80 percent owned by the state, said it would sell 2 billion pounds of notes to bolster capital.
"We recognize that there is still much work to be done to improve the resilience of our balance sheet," Chief Executive Ross McEwan said in a statement.
Britain's other large banks, HSBC, Standard Chartered, Santander UK and Barclays, scored comfortably in the test with pass rates of between 7 and 8.7 percent.
But the Bank of England warned that a stress test focused on emerging market shocks -- which would affect HSBC and Standard Chartered more -- could come in future and investors said none of the banks could afford to sit back.
"There will be no let-up even for those who passed with flying colors," said Neil Williamson, co-head of EMEA credit research at Aberdeen Asset Management.
