As the banking industry marks a decade since the collapse of Northern Rock and the global financial crisis that followed, a study by the Adam Smith Institute (ASI) has slated the Bank’s tests for “greatly overstating” the resilience of the British banking system.
The study claims the tests, which are designed to measure whether a bank could withstand a severe financial shock, give false comfort by overstating the resilience of the finance sector.
It said major UK banks remain too highly leveraged and would all fail a stress test if it was based on market value of bank capital rather than book value.
Professor Kevin Dowd, senior fellow of the ASI and author of the report, said: “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 the UK banks that simply isn’t there.
“It is disturbing that 10 years on from Northern Rock, the best measure of leverage – those based on market values – indicate that UK banks are even more leveraged than they were then.
“The biggest risk facing the UK banking system now is the Bank of England’s own complacency.”
The report also said the global financial crisis was exacerbated by high bank leverage, while market valuations of UK lenders indicate that some have hidden losses.
Asked whether efforts to root out bad behaviour within the financial system have worked, Prof Dowd told the Press Association: “The reform of corporate governance has been pretty menial.
“The problem is that senior bankers don’t have enough incentive to avoid excessive risks.
“There has to be strict liability of bank directors so they have serious skin in the game.
“The reason there has been so few prosecutions (over the financial crisis) is because it is hard to prove negligence.”
In response, Bank of England chief Mark Carney said: “As part of our stress testing approach, we construct a central projection of a bank’s capital position over a five year period, and then calculate how that capital position would change in response to a severe stress scenario.
“We use a baseline forecast of a bank’s profitability to construct the projection of its capital position.
“It is possible to back out an implied price to book ratio from this forecast, after making an adjustment for misconduct costs.
“We find that our baseline projection for the four largest UK banks equates to a price to book ratio of between 0.7 and 0.8, consistent with the actual price to book ratio at…