On 4 September 2019, the Bank of England (BoE) published a speech by Donald Kohn (External Member of the Financial Policy Committee) entitled Stress tests and the countercyclical capital buffer: the UK experience.
In his speech Mr Kohn reflects on the UK’s stress testing regime of the major banks highlighting some of the ways in which UK stress tests differ from those in the US. He also looks at the causes and consequences of procyclical risk-based bank capital and the role the Financial Policy Committee (FPC) envisions for the countercyclical capital buffer, informed by stress tests, in countering this tendency. He also discusses how the FPC has used the countercyclical capital buffer and stress tests in practice. Mr Kohn ends his speech by covering some challenges for the research agenda that would help the FPC be even more efficient and effective.
In his concluding remarks Mr Kohn warns that the countercyclical capital buffer and the stress tests have not yet been tested in an economic downturn. He adds that capital needs to build up sufficiently with risks so that when the countercyclical capital buffer is released those who are funding banks have the confidence to support banks’ efforts to continue lending to households and businesses even as the economy falls into recession. He also adds that the countercyclical capital buffer needs to be released promptly to allow banks the scope to make those loans even as losses begin to rise and that the stress test scenarios and results are fully supportive of an appropriate release.
The BoE is expected to release an updated approach to stress testing document later this year.