Bank of England Stress Testing 2.0

Introduction
 

On 24th March 2025, the Bank of England (“Bank”) published the first Bank Capital Stress Test (“BCST”). This exercise is the successor to the Annual Cyclical Scenario (“ACS”), with the last ACS exercise conducted in 2022/23. This is the first stress test conducted by the Bank since the publication of the updated approach to stress testing.

The 2025 BCST test is focused on testing the resilience of the in-scope UK banks to a range of adverse shocks in a hypothetical ‘tail risk’ scenario. The results of the stress test will be used to inform the setting of capital buffers. Underneath the cosmetic and anticipated changes, to title and frequency, there are actually some potentially big changes to how this year’s stress test might translate into banks’ capital buffers.

In this blog, we highlight the four most important areas that banks need to consider: the new scenario; the end of IFRS9 transitional relief and associated hurdle rate (the capital ratio against which banks are assessed in the stress test) adjustments; changes to how stressed CET1 capital ratio low points are assessed; and expected reductions in consumer credit losses.  

We further explore below two of the biggest changes in the BCST 2025:

• Expiry of IFRS 9 Transitional Arrangements
  The IFRS 9 accounting standard was implemented in January 2018, being the successor to the IAS 39 accounting standard. IFRS 9 mandated banks to establish provisions for the future expected credit losses on all loans – whereas previously it was only incurred losses for loans that were already in default.  From 1 January 2018 to 31 December 2024 participants could benefit from transitional arrangements. These arrangements meant that a specified percentage of new provisions (made due to the implementation of IFRS 9) could be added back to CET1 capital. The Bank anticipates that the expiry of complex transitional arrangements will make the stress test simpler and align it with the accounting standard that will apply in a real, future stress.
  
  
• Hurdle Rate Changes
  Since the 2018 ACS onwards, hurdle rates have been computed as the sum of:
  • Minimum risk-weighted capital requirements (Pillar 1 plus Pillar 2A)
  • Systemic risk buffers (for domestically and globally systemically important banks)
  • Adjustments to reflect the increased loss absorbency from higher provisions under IFRS 9

In the 2025 BCST the Bank will not use IFRS9 hurdle rate adjustments. Indeed, in judging the results of the 2025 BCST, bank low points will be published alongside minimum requirements instead of against hurdle rates.

What this means for banks
 

• Net interest income vs Impairments
  In a high-interest rate environment, banks must balance the interactions between higher net interest income and higher impairment. While elevated rates boost interest income, they also increase the likelihood of borrowers defaulting on loans, leading to higher loan loss provisions and asset impairment. Banks must carefully manage this dynamic to ensure profitability and financial stability amidst challenging economic conditions.
  
  
• Change to the benchmark against which banks assessed
  This year banks’ low points will be compared to their minimum requirements, whereas in the ACS low points were compared to hurdle rates that included systemic buffers as well. Combined with the BoE comments on lower expected consumer credit, this seems consistent with a less severe test. The Bank is likely anticipating a large impact due to expiry of IFRS 9 transitional arrangements. Ultimately, participating banks will need to form their own view about their resilience in this scenario considering all the various factors.
  
  
• Lower execution burden
  As the Bank has not asked for RFB results submissions and has not provided a baseline scenario for the 2025 BCST, participants are likely to benefit from a faster execution and governance timeline. However this should be balanced against the challenges of not having a relative reference point, of a base case scenario, to assess the stress impacts.
  
  
• Impacts on vulnerable sectors
  The scenario is one in which global trading relationships fragment, with sharp increases in energy prices and a trade war. Banks should expect this to translate into more pronounced impacts on sectors and firms that are export-oriented or import intensive, as well as those that are more exposed to food and energy prices.
  
  
• Impacts on consumer credit
  This is a clear area of focus for the BOE as also noted in the desk-based stress-test (DBST) exercise. Participants will need to consider how to balance the forces pushing up on consumer credit impairments (very high interest rates, high inflation and cost of living impacts, high unemployment) with the BoE’s expectation for lower consumer credit losses in the 2025 Bank Capital Stress Test than in past exercises (other things being equal).
  
  
• Internal Stress Testing
  While the 2025 BCST test provides a common reference point, banks should not solely rely on it. They would benefit by assessing that their internal stress testing and risk management practices are robust enough to handle potentially earlier and/or more severe economic downturns than those outlined in the stress test.

We have a lot of experience of BoE stress testing and our experts can help you to identify (i) areas of weakness in your current stress testing capability and framework; (ii) the scale of impact that the new approach can have for your organisation.

For further discussion on these insights, please contact us.