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July 12, 2018

BoE published a statement providing details on two changes to the way hurdle rates are calculated in the annual stress test. These changes are only relevant to firms under the Capital Requirements Regulation (CRR). In its document on the key elements of the 2018 stress test, which was published in March 2018, BoE had noted its intention to change the way hurdle rates are calculated in the annual stress test in four ways.

The two changes on which the statement provides details are as follows:

  • Hurdle rates will incorporate buffers to capture domestic systemic importance as well as global systemic importance.
  • The calculation of minimum capital requirements incorporated in the hurdle rates will more accurately reflect how they would evolve in a real stress.

The Systemic Risk Buffer (SRB) increases the capacity of certain UK systemic banks to absorb stress, reflecting their significance for the domestic economy. Beginning in 2019, SRB rates will be set for ring-fenced banks (RFB) and large building societies by PRA. For the purpose of the 2018 stress test, in calculating these uplifts to firms’ hurdle rates, PRA will assume the following SRB rates for the SRB institutions: 1% for Barclays, 1% for HSBC, 2.5% for Lloyds Banking Group, 1% for Nationwide, 1.5% for RBS, and 1% for Santander UK. These are assumed rates for the concurrent stress-test purposes only. Actual SRB rates for affected firms will be determined and published for the first time in 2019.

The annual stress test uses a risk-weighted hurdle rate, including Pillar 2A, which is a minimum capital requirement applied to cover a range of risks not (or not adequately) captured in Pillar 1. In the previous stress tests, the Pillar 2A element of the hurdle rate had been set as a constant share of risk-weighted assets over the five-year stress horizon. To ensure that the Pillar 2A requirements in the 2018 stress test more closely reflect the probable impact of stress on the risks captured in Pillar 2A, the Prudential Regulation Committee (PRC) has developed an approach in which each Pillar 2A risk component scales with a simple metric. This approach will preserve the current simplicity in the calculation of hurdle rates. These scaling bases are not intended to be forward guidance on how PRA will set Pillar 2A requirements in such a scenario; rather, they provide a simple way to ensure Pillar 2A requirements in the stress test more closely reflect the probable impact of the stress on the risks captured in Pillar 2A.

 

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Keywords: Europe, UK, Banking, Systemic Risk Buffer, Pillar 2A, Stress Testing, Stress Test 2018, Hurdle Rates, BoE

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