Stress testing the UK banking system: Key elements of the 2025 Bank Capital stress test
2: Key features of the test
The Bank is carrying out a Bank Capital Stress Test in 2025.
The Bank published its updated approach to stress testing the UK banking system in 2024.footnote [1] In line with this updated approach, the Bank expects to undertake a Bank Capital Stress Test every other year starting in 2025. This exercise is the successor to the annual cyclical scenario (ACS) under the previous approach, with the last such test being the 2022/23 ACS.footnote [2]
The 2025 Bank Capital Stress Test is a test of risks related to the financial cycle in which the largest and most systemic UK banks will participate. It will be used to inform the setting of capital buffers for the banking system and individual participating banks, and to inform a broader understanding of risks in the UK banking system. Results of the test will be informed by both the Bank’s and participating banks’ estimates of the impact of the scenario.
Seven banking groups will take part in the 2025 Bank Capital Stress Test.
The 2025 Bank Capital Stress Test will include the largest and most systemic UK banks and building societies, consistent with the criteria for participation set out in the updated approach to stress testing.
Seven banksfootnote [3] will take part in the test at the highest UK level of consolidation. Together these banks represent 75% of lending to the UK real economy.footnote [4] For the 2025 Bank Capital Stress Test, the Bank is not requesting additional submissions from the ring-fenced subgroups of banks on a standalone basis, but these subgroups may be included in future tests.
The 2025 Bank Capital Stress Test will assess the resilience of the UK banking system to a severe but plausible scenario.
Consistent with previous concurrent stress tests and as set out in the updated approach to stress testing, the 2025 Bank Capital Stress Test will test banks against a severe but plausible scenario. The stress scenario is not a forecast of macroeconomic and financial conditions.
Rather, like previous concurrent stress test scenarios, it is intended to be a coherent tail risk scenario designed to be severe and broad enough to assess the resilience of the UK banks to a range of adverse shocks. It is not a set of events that is expected, or likely, to materialise. This tail risk scenario is used for the purposes of enhancing financial stability and promoting the safety and soundness of UK banks. It is distinct from scenarios that the Monetary Policy Committee may use to illustrate the uncertainties around its forecasts.
The macroeconomic and financial scenario is intended to be countercyclical in nature and is informed by the FPC’s assessment of underlying vulnerabilities in the UK and global economies. All else being equal, such an approach would tend to result in banks having more capital as risks are building up and allows them to draw on capital buffers as the stress unfolds – thereby continuing to support the wider economy. The scenario also incorporates a stressed level of misconduct costs.
The scenario in the 2025 Bank Capital Stress Test will cover a five-year horizon, with a start point of end-December 2024. For some elements of the test, comparison to a baseline scenario is useful to support the analysis of stressed projections. However, the Bank recognises that producing projections for a baseline scenario in addition to a stress scenario can be onerous for banks, and as such they will not be requested to submit full projections for a baseline scenario. Instead, banks will be asked to submit projections based on their existing corporate plans in a small number of areas where it is deemed appropriate to ensure robust results.
Banks will not be required to submit projections on a basis consistent with Basel 3.1 standards, in line with the updated implementation timetable for these standards.footnote [5]
The Bank Capital Stress Test is used within the Bank’s broader framework for financial stability and safety and soundness.
The Bank Capital Stress Test is integrated with the Bank’s broader approach to assessing financial stability and safety and soundness. In addition to the core results of the test, sensitivity analysis can be used to assess the impact on bank resilience of varying key assumptions or elements of the macroeconomic scenario. Supplementary analysis may also be used to assess an additional risk to those in the core test and to inform the FPC and PRC’s broader assessment of vulnerabilities.
In designing the 2025 test, the Bank has drawn on insights from other stress tests it carries out, including those across the broader financial system. For example, the calibration of the financial market stress is consistent with insights from the 2024 System Wide Exploratory Scenario exercise as appropriate.
Box A: Incorporating IFRS 9 in the stress test
The changes set out in this box, made alongside the ending of IFRS 9 transitional arrangements, are designed to be consistent with an unchanged FPC and PRC risk tolerance for the resilience of the UK banking system.
This is the first stress test since the end of transitional arrangements for the IFRS 9 accounting standard, introduced in 2018.footnote [6] The FPC has judged that the change in accounting standards should not lead to an unwarranted increase in capital requirements for the banking system.
In this context, the Bank has reviewed the calibration of its stress test and is implementing a number of changes relative to previous concurrent stress tests. The Bank is making these changes due to the increased resilience for a given level of capital provided by the earlier recognition of losses under IFRS 9. In aggregate, the changes are designed to be consistent with an unchanged FPC and PRC risk tolerance for the resilience of the UK banking system.
Furthermore, the removal of complex transitional arrangements and adjustments make the test simpler and aligned with the accounting standard that would apply in an actual stress. The changes make the stress test more consistent with historical advanced economy stresses in terms of the size and timing of the shocks, and more reflective of how the CCyB would evolve in a real stress.
Background
IFRS 9 was introduced in 2018 in part to increase transparency in measures of banks’ capital positions through the earlier recognition of credit losses in banks’ provisioning, addressing a key lesson learned from the global financial crisis (GFC).
On 1 January 2018, major UK banks implemented the IFRS 9 accounting standard. Under IFRS 9, banks set aside provisions for expected credit losses on all loans – not just loans that are past due or are already in default. Banks are therefore expected to set aside provisions to cover credit losses earlier than under the previous accounting standard, International Accounting Standard 39 (IAS 39). Under IAS 39, credit losses were recognised only once there was objective evidence a loss event had occurred (known as an ‘incurred loss’ basis).
The earlier recognition of losses under IFRS 9 enhances transparency and market confidence in measures of banks’ capital positions, including in a downturn, thereby supporting financial stability and the safety and soundness of individual banks. IFRS 9 reduces the risk of banks being under provisioned for losses that occur later in a stress.
All else equal, the earlier recognition of losses in a stress under IFRS 9 leads to sharper capital drawdowns in the early part of the stress test than under the previous accounting standard.
The change in accounting standard does not change the actual cumulative losses banks incur during any given stress episode. The losses will, however, be provided for earlier in the stress. All else equal, bank capital, as measured under IFRS 9, is likely to fall more sharply in the early part of a stress as capital is drawn down earlier to raise provisions. By default, this would mean that banks need to have larger capital buffers to withstand the same stress test scenario.
In 2018, the FPC judged that the necessary level of loss-absorbing capacity was invariant to accounting standards and that it would therefore seek an enduring treatment for IFRS 9 in the stress test that avoided an unwarranted increase in capital requirements.
The appropriate level of Tier 1 capital in the UK banking system is calibrated so that banks can absorb losses during a severe stress and continue to provide essential services to the real economy. The FPC has judged the appropriate level of capital to be invariant to accounting standards.
As such, the Bank has sought a way of incorporating IFRS 9 into the stress test which avoids an unwarranted increase in capital requirements. It has sought to follow three guiding principles as it incorporates IFRS 9 into the Bank Capital Stress Test:
- The stress test should embody a risk tolerance consistent with previous concurrent stress tests. This includes both avoiding an unwarranted increase in capital requirements and continuing to hold systemic banks to a higher standard than non-systemic banks.
- The test should reflect how banks’ capital positions would unfold in a real stress and be implemented in a practical way.
- The incorporation of IFRS 9 into the stress test should be transparent and compliant with international standards.
In previous tests, the effect of earlier provisioning under IFRS 9 in the stress scenario had been managed by internationally agreed transitional arrangements and adjustments to the hurdle rate framework. The transitional arrangements have now come to an end and the hurdle rate adjustment was intended to be temporary until an enduring treatment could be identified.
Internationally agreed arrangements were put in place to offer banks transitional relief as they adapted to the new accounting standard. These arrangements allowed banks to ‘add back’ to Common Equity Tier 1 (CET1) capital a specified percentage of ‘new’ provisions made due to the adoption of IFRS 9. These transitional arrangements expired on 31 December 2024. Additionally, since 2018 the Bank has adjusted hurdle rates – the level of capital that banks are expected to maintain in the stress scenario – to take into account the impact of the IFRS 9 accounting standard. Together, these measures were intended to manage the capital impacts of using IFRS 9 in past stress tests.
Hurdle rate adjustments were intended to be temporary and were complex to implement. They were subject to a constraint that no bank should have a hurdle rate that is below its minimum risk-weighted capital requirements (Pillar 1 plus Pillar 2A), and comparably for leverage ratio requirements. This meant that the hurdle rate adjustment could be no larger than a bank’s systemic risk buffer. As a result, if the Bank continued to use hurdle rate adjustments, some banks could still see increased PRA buffers as the IFRS 9 transitional arrangements end.
Reflecting the end of IFRS 9 transitional arrangements and the limitations of the hurdle rate adjustment, the Bank will not use hurdle rate adjustments for the 2025 Bank Capital Stress Test.
The Bank does not consider it appropriate to deliver the enduring treatment for IFRS 9 through changes to the capital framework, given the complexity of such a solution and the importance of complying with international capital standards.
The Bank has considered options for an enduring treatment for IFRS 9 which involve making changes to the capital framework to recognise the resilience provided by earlier recognition of losses under IFRS 9. This includes the proposals to adjust minimum capital requirements discussed in the December 2019 Financial Stability Report,footnote [7] as well as the potential for a permanent corresponding change in CET1 capital to offset the impact of IFRS 9. However, to varying degrees these different options would be complex to implement, inconsistent with the intended purposes of IFRS 9, or inconsistent with Basel capital standards.
Incorporating IFRS 9 into the stress test
The Bank intends to make changes to the stress-testing framework that are simpler to deliver and ensure that the resilience that comes with earlier provisioning is recognised, consistent with the intention of IFRS 9.
For the first Bank Capital Stress Test, the Bank has updated its approach for stress-test calibration which has resulted in a number of changes relative to previous concurrent stress tests, which are appropriate to make alongside the earlier provisioning under the IFRS 9 accounting standard:
- The Bank has reviewed the timing and transmission of shocks in the stress scenario, delaying the timing of the peaks and troughs of key macroeconomic variables such as unemployment, real GDP and property prices. This will lead to some credit losses being recognised later in the exercise. See Box B for more details.
- The approach to setting the size of shocks in the scenario has been updated to incorporate additional data to ensure consistency with historical experience and to simplify the methodology. This updated methodology has resulted in the start-to-tough changes in some variables being somewhat smaller over the scenario horizon than they otherwise would have been, although the impact on the aggregate capital drawdown is likely to be small. See Box B for more details.
- Having reviewed past judgements and recent evidence on consumer credit quality, all else equal, the Bank expects to allow for lower consumer credit losses in the 2025 Bank Capital Stress Test than in past exercises. Previously, it was judged that an improvement in consumer credit performance seen in the data was driven largely by improvements in the macroeconomic environment rather than underlying improvements in credit quality.footnote [8]
In addition to changes to the stress-test calibration, the Bank will consider the impact of IFRS 9 in using the results of the Bank Capital Stress Test when forming a view on resilience and to inform the setting of PRA buffers.
Stress testing provides an insight into the ability of the banking system to withstand an adverse scenario. As such, the results of the Bank Capital Stress Test will be an input to the PRA’s assessment of individual banks’ capital adequacy, including through the PRA buffer-setting process.footnote [9] The stress test is one of a range of inputs and there is not a mechanical link between this and the PRC’s view on the level of capital at a specific bank.
In setting the PRA buffer, one input is the excess amount of capital that would be needed over and above the Capital Conservation Buffer (CCoB) and relevant countercyclical capital buffer (CCyB) to withstand a severe but plausible stress. The PRA buffer also takes into account an assessment of risk management and governance alongside supervisory judgement. In turn that supervisory judgement includes an assessment of any other relevant information.
To reflect the impact of IFRS 9 when setting the PRA buffer, the Bank will create space for a greater capital drawdown in the stress scenario by assuming a UK CCyB rate that reflects the FPC’s expectation that it would set the CCyB rate at 2% in a standard risk environment.footnote [10] This brings the stress test in line with a real stress, in which banks would be able to make use of the higher starting CCyB.
The impact of these changes will be considered when applying supervisory judgement around the calibration of PRA buffers. The Bank will use this year’s test to assess the impact of the changes set out in this box and to inform the appropriate benchmark against which to assess banks in future stress tests.
In addition to the changes set out above, when applying supervisory judgement in this test the PRA will consider, among other factors, the guiding principles for incorporating IFRS 9 in stress testing. In particular, in considering the resilience of individual banks to the stress scenario and setting PRA buffers, the PRA will consider the level and nature of provisions under IFRS 9, and evidence on the impact of the changes outlined in this box on individual banks’ stress test results.
In line with international standards, systemic banks should be expected to withstand a stress that is more severe than non-systemic banks. This is reflected in systemic buffers, which provide additional resilience to systemic banks commensurate with the additional costs their failure would impose on the wider economy.
Under the approach set out in this box, it is possible that a bank’s capital position in the stress test could fall below the sum of its minimum requirements and its systemic buffer without the PRA judging that it requires additional resilience. Therefore, in the publication of the results of the 2025 Bank Capital Stress Test, bank-specific low points in the scenario will be published alongside minimum requirements.
The Bank will use this year’s test to assess the impact of the changes set out in this box and to inform the appropriate benchmark against which to assess banks in future stress tests.
These changes to the test support the FPC’s and PRA’s primary and secondary statutory objectives.
These changes to the test ensure that the Bank Capital Stress Test will allow an assessment of the resilience of the UK banking system to a severe but plausible scenario, consistent with the FPC’s primary financial stability objective and the PRA’s primary objective for safety and soundness.footnote [11]
Using the stress test to ensure banks can absorb severe but plausible shocks and continue to lend to the UK economy, while taking action to avoid an unwarranted increase in capital requirements, supports the FPC’s secondary objective and the PRA’s secondary growth and competitiveness objective.
3: Macroeconomic variables in the scenarios
3.1: The scenario narrative: global aggregate supply shock
There is a severe global aggregate supply shock, which leads to deep recessions across countries.
The scenario for the 2025 Bank Capital Stress Test includes a severe global aggregate supply shock, which leads to deep recessions across the world. An escalation of geopolitical tensions leads to a sharp increase in commodity and energy prices. Oil prices increase by over 100% and gas prices by over 300% to levels comparable with those experienced during 2022.
Global trading relationships fragment leading to severe supply chain disruptions, which contributes to a large fall in world trade volumes.
There is a fragmentation of global trading relationships leading to shortages in key production inputs and a slowdown across major transportation routes. This increases world export price inflation and in turn domestic inflation, as producers search for new suppliers and manage these shortages – an effect like that experienced in the years after the Covid pandemic. In addition, major trading nations impose import tariffs.
These factors contribute to a 20% fall in world trade volumes.
Together these shocks lead to a sharp rise in inflation across advanced economies, and central banks raise interest rates to bring inflation back to target.
The combination of shocks leads to higher-than-expected inflation across advanced economies. Inflation in the UK increases to a peak of 10% at the end of 2025 (Chart 1). The rise in inflation is assumed to cause expectations of higher inflation for some time, which also puts upward pressure on wage growth. This creates a challenging trade-off between stabilising GDP growth and returning inflation to its target.
To prevent inflation expectations becoming entrenched, policymakers increase interest rates to bring inflation down. In the scenario, Bank Rate increases to 8% by the end of 2025 and is then lowered over the scenario as inflation returns to its 2% target (Chart 2). The MPC continues quantitative tightening, reducing the volume of gilts in the Asset Purchase Facility by £100 billion a year using a combination of active sales and allowing bonds to mature.
Chart 1: UK inflation increases sharply in the stress scenario
UK CPI in the 2025 Bank Capital Stress Test
- Sources: Office for National Statistics (ONS) and Bank calculations.
Chart 2: Bank Rate is increased to bring inflation back to target
Bank Rate in the 2025 Bank Capital Stress Test (a)
Higher energy prices, particularly gas prices, tend to increase the price of allowances in emissions trading schemes, as seen in the period following Russia’s invasion of Ukraine. The Bank is not asking participating banks to undertake analysis of the impact of such moves in this exercise over and above their existing ways of incorporating such moves into their stressed projections. As set out in the November 2024 Financial Stability Report, the FPC will continue to consider how to embed climate risks in the stress-testing framework where appropriate as part of its work to consider how risks from climate change could impact financial stability.
The effects of rising costs fall unevenly across households and businesses.
Sectors with a greater reliance on imports, as well as those more exposed to energy and food prices, are particularly affected in this scenario. UK corporate profits net of energy extraction industries fall by 4.5% in the early years of the scenario. In contrast, the energy extraction industries receive a short-term benefit from higher wholesale oil and gas prices.
Over time, businesses pass these higher costs through to prices, contributing to high inflation, and putting further pressure on households’ real incomes. Lower-income households, whose essential spending represents a larger share of their income, are disproportionately affected.
3.2: GDP and unemployment
The stress scenario is benchmarked to historical advanced-economy stresses and informed by the FPC’s view of domestic and global risks.
The scenario used in the Bank Capital Stress Test is intended to be severe but plausible, and to vary with the state of the financial cycle.
As a starting point in designing the scenario, the Bank takes the first percentile of the historical distributions of changes in key macroeconomic variables across advanced economies. These changes are then benchmarked to the GFC.
Judgements are then applied to certain variables to reflect the FPC’s assessment of domestic and global vulnerabilities. These include countercyclical judgements, which increase the size of shocks when vulnerabilities to particular regions or markets have increased and reduces the size of shocks when risks have abated or crystallised.
Box B contains more details on the Bank’s approach to scenario calibration, and how it has been updated.
There is a severe domestic recession in the UK with a large fall in real GDP and an increase in unemployment.
There is a deep recession in the UK as real GDP falls by 5% (Chart 3). UK unemployment increases, peaking at 8.5% in the third year of the scenario (Chart 4), similar to the peak level experienced in the GFC and the same as the peak used in the 2022/23 ACS (Table A).
Chart 3: There is a deep recession in the UK
UK real GDP in the 2025 Bank Capital Stress Test
- Sources: ONS and Bank calculations.
Chart 4: UK unemployment increases materially
UK unemployment rate in the 2025 Bank Capital Stress Test
- Sources: ONS and Bank calculations.
Table A: UK macroeconomic variables (a) (b)
Variable |
2025 Bank Capital Stress Test |
2022/23 ACS |
Global financial crisis |
|---|---|---|---|
Real GDP (change, %) |
-5 |
-5 |
-6.4 |
Unemployment rate (peak, %) |
8.5 |
8.5 |
8.4 |
Bank Rate (level, %) |
8 |
6 |
0.5 |
CPI inflation (level, %) |
10 |
17 |
4.8 |
- Sources: Bank of England, ONS and Bank calculations.
- (a) Figures in the table are based on quarterly or quarterly average data.
- (b) Bank Rate figures show the peak level except for the GFC which is the trough level. UK unemployment figures show the peak level. CPI inflation is shown as the peak 12 month percentage change in CPI. UK real GDP is shown as peak-to-trough changes.
The global aggregate supply shock also leads to deep recessions across the world.
The impact of the global aggregate supply shock on non-UK jurisdictions is summarised in Table B. Relative to the 2022/23 ACS, the impact on euro-area macroeconomic variables is a little smaller, reflecting the updated approach to calibrating these shocks set out in Box B. In the US, the unemployment rate peaks a little higher than in 2022/23, reflecting the continued build-up of risks and vulnerabilities.
In mainland China and Hong Kong, the shocks to real GDP and unemployment over the stress scenario are larger than those calibrated in the 2022/23 ACS. When calibrating the 2022/23 ACS, real GDP had started falling and risks were judged to be crystallising in the data, so further shocks over the stress scenario were reduced in size. Following the recovery in real GDP and unemployment since then, the shocks to these variables over the 2025 stress scenario have been increased accordingly. The shock to mainland China GDP also reflects lower trend growth rates expected in the region over the scenario horizon compared to the 2022/23 ACS.
Table B: Summary of the global macroeconomic shocks (a) (b)
Region |
Variable |
2025 Bank Capital Stress Test |
2022/23 ACS |
Global financial crisis |
|---|---|---|---|---|
US |
Real GDP (change, %) |
-4 |
-4.1 |
-4 |
Unemployment rate (peak, %) |
9 |
8.6 |
9.9 |
|
Euro area |
Real GDP (change, %) |
-4 |
-4.9 |
-5.7 |
Unemployment rate (peak, %) |
11 |
11.9 |
10.4 |
|
Hong Kong |
Real GDP (change, %) |
-8 |
-6.9 |
-7.5 |
Unemployment rate (peak, %) |
7.5 |
7.7 |
5.4 |
|
Mainland China |
Real GDP (change, %) |
-2 |
-0.1 |
|
World |
PPP-weighted real GDP (change, %) |
-2 |
-2.5 |
-2.1 |
Market exchange rate-weighted import volumes (change, %) |
-20 |
-17.1 |
-14.7 |
- Sources: Bureau of Labor statistics, Eurostat, Hong Kong Census and Statistics Department, International Monetary Fund World Economic Outlook, National Bureau of Statistics China, Refinitiv Eikon from LSEG, US Bureau of Economic Analysis and Bank calculations.
- (a) Figures in the table are based on quarterly data.
- (b) Real GDP figures are shown as start-to-trough changes for 2025 Bank Capital Stress Test and 2022/23 ACS, while the GFC real GDP figures are shown as peak-to-trough changes. Real GDP in mainland China did not fall during the GFC so this is not shown on the table. Unemployment rates are shown as their peak level.
3.3: Property prices: commercial real estate (CRE) and residential property
UK house prices fall sharply in the scenario, and UK CRE prices fall in addition to recently observed price falls.
UK house prices fall 28% in the scenario (Chart 5). The fall is smaller than in the 2022/23 ACS due to the removal of a countercyclical judgement that vulnerabilities in the housing market were elevated due to rapid house price growth in some regions in 2021 and 2022 following the onset of the Covid pandemic. Supporting the removal of that judgement, house price to income ratios and other indicators of housing affordability have fallen since the 2022/23 ACS.
Chart 5: UK house prices fall materially
UK house prices in the 2025 Bank Capital Stress Test
- Sources: ONS and Bank calculations.
UK CRE prices fall 50% from their peak level in mid-2022 to the trough of the stress in 2026. Given CRE prices have already declined by around 20% from their mid-2022 peak, this implies a further fall of 35% from the start point of the scenario to the trough. This peak-to-trough decline incorporates a judgement to enhance the severity of the fall in UK CRE prices, due to a degree of overvaluation when prices were at their peak.
Global residential and commercial property prices also fall sharply in the scenario.
Over recent years, property prices have fallen across several regions, with large falls in CRE prices. The Bank has accounted for these price falls in the calibration of the stress scenario, reducing the start-to-trough shocks where there is evidence that existing risks have now crystallised (Chart 6).
The stress applied to euro-area CRE prices has been increased relative to the 2022/23 ACS to reflect a judgement that the peak-to-trough fall would be similar to that of US and UK CRE prices (of around 50%), given comparable headwinds facing global CRE markets.
Chart 6: UK and global economies experience large falls in property prices
Changes in residential property and CRE prices in the 2025 Bank Capital Stress Test (a) (b)
- Sources: ECB, Federal Reserve Board, National Bureau of Statistics of China, ONS, Rating and Valuation Department, the Government of the Hong Kong Special Administrative Region, Refinitiv Eikon from LSEG and Bank calculations.
- (a) The scenario does not include a projection for CRE prices in mainland China due to data limitations.
- (b) UK and euro-area CRE price falls to date are calculated as changes from their peak values in 2022 Q2, US CRE prices from their peak in 2023 Q2, Hong Kong house prices from their peak in 2021 Q3, Hong Kong CRE prices from their peak in 2018 Q4 and mainland China CRE prices from their peak in 2021 Q3.
As highlighted in the November 2024 Financial Stability Report, vulnerabilities in the property sector in mainland China and Hong Kong remain elevated, with falling house prices and weak activity observed. In the scenario, mainland China house prices fall by 35% from peak to trough and Hong Kong house and CRE prices by 45% and 65% respectively from peak to trough.
3.4: Financial markets and traded risk
Increased risk aversion affects financial markets, leading to large falls in asset prices.
Global financial conditions tighten significantly from the start of the scenario. Uncertainty and risk aversion in financial markets increase as market participants anticipate the global decline in activity. Measures of market-implied volatility rise, with the CBOE volatility index (VIX) increasing to a peak of 45, similar to the 2022/23 ACS. Table C summarises the financial market shocks in the stress scenario.
Table C: Summary of the financial markets stress (a) (b) (c)
Variable |
Region |
2025 Bank Capital Stress Test |
2022/23 ACS |
Global financial crisis |
|---|---|---|---|---|
Government bond yields (peak, %) |
UK 1 year |
8.0 |
6.2 |
5.7 |
UK 10 year |
6.4 |
5.3 |
5.1 |
|
UK 20 year |
7.3 |
5.8 |
4.8 |
|
US 10 year |
6.4 |
6.1 |
4.9 |
|
Germany 10 year |
4.8 |
4.1 |
4.3 |
|
Equity prices (change, %) |
UK |
-48 |
-45 |
-40 |
US |
-57 |
-49 |
-46 |
|
Corporate bond spreads (peak, basis points) |
Sterling investment grade |
500 |
419 |
491 |
Sterling high yield |
2,300 |
1,953 |
2,323 |
- Sources: Bloomberg Finance L.P., ICE/BofAML Global Research and Bank calculations.
- (a) Data are quarterly averages.
- (b) For equity prices, figures for the 2025 Bank Capital Stress Test and the 2022/23 ACS show start-to-trough changes while figures for the GFC are peak-to-trough changes. UK equity prices are the quarterly average of FTSE All-Share price index. US equity prices are the quarterly average of S&P 500 price index.
- (c) Corporate bond spreads are the quarterly average option adjusted spread over maturity-matched government spot curve on local currency-denominated investment-grade corporate debt publicly issued in the domestic market. UK data also includes corporate debt publicly issued in the Eurobond market.
Elevated sovereign debt levels in advanced economies put further upward pressure on government bond yields.
In the stress scenario, term premia on government bonds increase significantly reflecting the rise in uncertainty, risk aversion and high levels of sovereign debt in advanced economies. Combined with the tightening in monetary policy, government bond yields rise rapidly. Ten-year government bond yields peak at 6.4% in the UK and US.
Spreads widen between government bond yields and overnight indexed swap (OIS) rates. The spread between 10-year UK government bonds and the 10-year Sterling Overnight Index Average (SONIA) swap rate widens to 90 basis points at the peak of the stress (Chart 7). This is higher than the peak quarterly average swap spread observed since 2008 of around 70 basis points.
Chart 7: Government bond yields and swap rates increase
Ten-year UK government bond yields and SONIA swap rates in the 2025 Bank Capital Stress Test
- Sources: Bloomberg Finance L.P. and Bank calculations.
Global equity prices fall and corporate bond spreads widen in the scenario.
Global equity prices fall in the stress. In the UK, the FTSE All-Share index falls by 48% from the start of the scenario (Chart 8). In the US, the Standard & Poor’s (S&P) 500 index falls 57%, consistent with the compression of risk premia at the end of 2024.
Investment-grade and high-yield corporate bond spreads widen, in line with deteriorating macroeconomic conditions and the financial market shock, and reach similar peaks as those experienced in the GFC. UK investment-grade spreads peak at 500 basis points, while high-yield spreads peak at 2,300 basis points. US investment-grade spreads peak at 580 basis points, while high-yield spreads peak at 1,700 basis points.
The increase in sterling corporate bond spreads in the scenario is consistent with the risk that the market could face a ‘jump to illiquidity’ in stress, where the speed of selling pressures significantly exceeds purchasing capacity and prices need to fall rapidly for the market to clear – a finding of the 2024 system-wide exploratory scenario.footnote [12]
The tightening in equity markets and corporate bond markets is accompanied by a stress in private markets, with the returns on private investment funds (including private equity funds) declining in the stress, reflecting a deterioration in the performance of these funds’ underlying portfolio companies.
Chart 8: Equity prices fall sharply
Equity prices in the 2025 Bank Capital Stress Test
- Sources: Bloomberg Finance L.P. and Bank calculations.
The calibration of the traded risk scenario reflects developments in financial markets as well as the macroeconomic scenario.
The 2025 Bank Capital Stress Test includes a traded risk scenario that has been designed to be consistent with the macroeconomic scenario and to take account of the liquidity of trading book positions. This will principally affect the investment banking operations of UK banks.
The traded risk component of the stress test requires banks to apply shocks to their market risk positions as of 28 February 2025. The Bank’s approach to traded risk takes account of different liquidity horizons by imposing larger shocks on positions that banks would take longer to close out, and smaller shocks for those positions that could be sold or hedged within shorter time frames.
The test will also examine the ability of banks to withstand the default of seven counterparties that would be vulnerable to the macroeconomic scenario. In determining the counterparties to default, banks should consider both the current creditworthiness of their counterparties, and how that creditworthiness might deteriorate under the stress scenario.
In addition to specific counterparty defaults, the scenario will test the portfolio impact from default losses amongst a cohort of counterparties that are vulnerable under the stress scenario.
3.5: Lending in the stress
The 2025 Bank Capital Stress Test is calibrated on the assumption that banks continue to support the economy, including through lending in the stress.
The FPC will use the stress test to assess whether the banking system is sufficiently well capitalised to support the real economy in the face of severe adverse shocks. This includes by meeting the demand for credit by creditworthy households and businesses in the UK real economy, at a price consistent with the overall scenario.
3.6: Misconduct risk
Banks will be assessed against stressed misconduct costs beyond those already paid or provisioned for.
In line with previous concurrent stress tests, the 2025 BCST will incorporate stressed projections for potential misconduct costs beyond those paid or provided for by the end of December 2024. Banks are asked to include misconduct costs which relate to known misconduct issues, and to provide stressed projections for these issues which have a low likelihood of being exceeded.
4: How the test will be used
4.1: Policy response and use in capital setting
The Bank Capital Stress Test is used within the Bank’s broader framework for financial stability and safety and soundness. The results will be used to inform the setting of capital buffers.
As the Bank’s approach to stress testing sets out, the Bank Capital Stress Test is integrated with the Bank’s broader approach to assessing financial stability and safety and soundness. By providing an assessment of the amount of capital that banks need to withstand a severe but plausible stress while continuing to support the real economy, it will be one input among a range of tools that the FPC and PRA can use in determining the size of capital buffers.
If the results of a Bank Capital Stress Test indicate that capital buffers or requirements are insufficient to be able to withstand the stress, the FPC and the PRA have a number of policy levers they can use in response. These include system-wide tools set by the FPC – such as the CCyB – and bank-level tools such as the PRA buffer. Conversely, if the assessment shows the current setting of regulatory capital buffers to be more than sufficient, the FPC and the PRA may act to reduce them.
However, there is not a mechanical link between the stress test results and the FPC’s view on the appropriate level of system-wide capital or PRC’s view on the level of capital a specific bank should have. The PRA will continue to use supervisory judgement when using the results of the test to set PRA buffers.
Box A sets out more information on how the Bank will use the results of the 2025 Bank Capital Test in the context of changes being made to incorporate the IFRS 9 accounting standard into the stress test.
In addition to the core results of the test, sensitivity analysis can be used to assess the impact on bank resilience of varying key assumptions or elements of the macroeconomic scenario. Supplementary analysis may also be used to assess an additional risk to those in the core test and to inform the FPC and PRC’s broader assessment of vulnerabilities.
4.2: Publication of results
The results of the 2025 Bank Capital Stress Test will be published in 2025 Q4.
The results of the 2025 Bank Capital Stress Test will be published in 2025 Q4 and will include results at an aggregate level and at the level of individual banks.
Box B: Approach to calibrating the size and timing of shocks in the stress scenario
The Bank has updated its approach to calibrating key variables in the stress test.
For the 2025 Bank Capital Stress Test, the Bank has updated how it sets the size and timing of shocks to key macroeconomic variables in the stress scenario. These changes make the calibration simpler and more aligned with past stress episodes. Taken together with the end of IFRS 9 transitional arrangements and the other measures outlined in Box A, these changes are designed to be consistent with an unchanged FPC and PRC risk tolerance for the resilience of the UK banking system.
Size of shocks to key variables
Shocks to key macroeconomic variables are benchmarked to historical experience and incorporate the FPC’s assessment of domestic and global vulnerabilities.
As a starting point in calibrating the scenario, the Bank takes the first percentile of the historical distributions of changes in key macroeconomic variables across advanced economies. These changes are then benchmarked to the GFC.
Judgements are then applied to certain variables to reflect the FPC’s assessment of domestic and global vulnerabilities. These include countercyclical judgements, which increase the size of shocks when vulnerabilities to particular regions or markets have increased and reduce the size of shocks when risks have abated or crystallised.
These adjustments will depend on the extent to which a stress is a crystallisation of risks identified previously, or instead if the distribution of possible outcomes has worsened in such a way that it may be appropriate to deepen the troughs in the scenario.
This is in line with the approach to countercyclicality as set out in the Bank’s published approach to stress testing. All else being equal, such an approach would tend to result in banks having more capital as risks are building up and allows them to draw on capital buffers as the stress unfolds – thereby continuing to support the wider economy.
Once the shocks to key variables have been calibrated, the Bank uses these as inputs for designing the rest of the scenario. This helps to ensure that the scenario is economically coherent and in line with the FPC’s and PRC’s risk tolerance.
The Bank has updated its methodology for estimating the distributions of historical changes.
The new methodology includes data from a wide set of advanced economies from 1970 onwards.footnote [13] The methodology has also been improved and simplified which means the historical distributions better reflect regional differences in the volatility and trend growth rates of the macroeconomic variables. All else equal, this updated method has resulted in a reduction in the starting size of some shocks in the stress scenario, although the impact on the aggregate capital drawdown is likely to be small.
The size of shocks in the scenario are also informed by the FPC's latest risk assessment and the Bank’s countercyclical approach to scenario design. In practice, this means that several shocks calibrated in the 2025 Bank Capital Stress Test are larger than the 2022/23 ACS due to changes in the FPC’s views of vulnerabilities in certain markets and jurisdictions.
Timings of key variable paths
The timing of the peaks and troughs of key variables in the stress scenario are also benchmarked to historical experience.
The timing of peaks and troughs in key scenario variables depends on the nature of the shocks themselves and the transmission channels of the shocks to the real economy.
Under its updated approach, as a starting point the Bank considers historical evidence across advanced-economy stresses and the experience of the GFC, to which judgement can then be applied to reflect the FPC’s assessment of domestic and global vulnerabilities.
In the 2025 Bank Capital Stress Test, the resulting timing of the peaks and troughs of key macroeconomic variables are more closely aligned to the average of historical advanced-economy stresses and the GFC.
In the stress scenario, the level of unemployment peaks in the ninth quarter across jurisdictions. This is later than in the 2022/23 ACS where UK unemployment, for instance, peaked in the sixth quarter of the stress scenario. For other variables such as UK real GDP and house prices, the updated approach moves the trough back by one quarter. A comparison of the timing of the core shocks in the 2025 Bank Capital Stress Test and the 2022/23 ACS is shown in Table 1.
Table 1: Timing of peaks/troughs in key UK variables in the 2025 Bank Capital Stress Test
Quarter of the peak/trough from the start of the stress |
||
|---|---|---|
Variables |
2025 Bank Capital Stress Test |
2022/23 ACS |
Unemployment rate |
9 |
6 |
Real GDP |
5 |
4 |
House prices |
12 |
11 |
- Source: Bank calculations.
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