Bank of England mocks up crisis scenario for new bank stress test

The banking regulator aims to test the banks' limits Photo: Yui Mok/PA (Yui Mok/PA)

The Bank of England has set out the stipulations for its rigorous new stress test for commercial banks which lay out a crisis situation.

The Bank painted a picture of GDP plummeting by 3.5%, house prices dropping by 35% and inflation soaring to 6.5% by the end of 2016. Other elements of the scenario included unemployment spiking to 12% and the trade-weighted value of sterling crashing by 30%.

The Bank's recession scenario includes interest rates jumping from the present record lows of 0.5% to 4%. It envisages a 30% crash in the UK stock market.

The stress test, which will be imposed on top of the European Union's own exercise, will be conducted over the summer and autumn and concluded by the end of the year.

The Bank said the UK's eight largest lenders would be expected to have capital ratios of risk-weighted assets even after experiencing such a shock of 4.5%.

At the moment they are reporting capital ratios well above that level. Lenders that fail the stress test would be directed to raise their capital levels now.

The Banks stressed the scenario was "extreme" and "highly unlikely to transpire" but added that it was the right test of lenders' robustness.