Northern Rock 10-years on: why European banks are still feeling stressed

By Khrystyna Andronova, consultant at Delta Capita

Where did that decade go? Can it really be ten years this month since that symbolic queue of people frantically trying to get their cash out of Northern Rock? The 2008 crisis changed the income growth trajectory for the UK economy. According to the Institute for Fiscal Studies (IFS), the lost growth will have cost workers £5,900 per year for a childless couple and £8,300 for a couple with children. As for the banks that made it through intensive care, they are also coping with their own stresses and strains, albeit of a very different kind, such as increased regulation and supervision.

As people still got to grips with the new economic paradigm of ultra-low rates and frequent bouts of QE, European and American bank supervisors put in place stress testing frameworks to determine whether individual banks could withstand severe economic conditions. Following the systemic failure of the governance of financial regulation that led to the crisis in 2008, stress testing was introduced and has become vastly more sophisticated in recent times.

Some banks are, without question, much better placed to leverage on the stress testing findings, and make more efficient use of capital and mitigate the risk. Others, on the other hand, still find themselves in a somewhat precarious position and struggle to develop effective regulatory and internal stress testing capabilities. Over the last year, banks across Europe have continued to encounter issues. Royal Bank of Scotland (RBS), for example, failed the last round of stress tests and, in Italy, Monte dei Paschi was forced to turn to a state bailout after failing to raise adequate capital. Similarly, recent stress tests carried out by two European financial watchdogs, found 68 small and medium-sized German banks to have insufficient capital requirements.

Against the backdrop of an uncertain geopolitical landscape, the problem is that markets today are increasingly complex and move faster to the point that rule makers can’t keep up. As a result, banks are advised to embed their findings from stress testing into their decision-making process to be better prepared for an unforeseen market event. On top of this, many of the non-performing loans (NPLs), which weigh so heavily on the balance sheet, are still being sold off in order to meet capital requirements.

A combination of trying to offload NPLs and unpredictable global market conditions is exactly why more needs to be done. There’s certainly capacity for scenarios to become more diverse and inventive, not to mention frequent. This would provide a much more effective backstop for the capital that banks are supposed to hold for any possible situation. Only with this kind of overarching approach can the world be confident that the process of making banks safer is not simply shifting risk elsewhere. This may sound simple, but if the last ten years has taught us anything, it is that carrying out rigorous and full proof stress testing is desperately complicated in practice. As the Bank of England (BofE) recently stated, sound banking models do not just focus on how much capital a bank has in reserve – this is an oversimplification. It is about looking at other ways to mitigate against a future crisis through building more sustainable models that move away from short term risk taking.

Collaboration between consultancy and fintech firms specializing in creating advanced agent based models should be encouraged in order to increase the operational efficiency and reliability of stress testing results, making it less of an ordeal for those involved. For example in the UK, with more stress tests looming over the coming months and every quarter thereafter, more and more banks will be turning to these firms for internal pre-testing to ensure they are best prepared for the next time their financial stability goes under the microscope. After all, no bank wants to risk becoming, like Northern Rock, the defining image of the next financial crisis.