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UK bank system is “accident waiting to happen”

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A decade after the collapse of Northern Rock, a leading think tank has warned the UK banking system is “an accident waiting to happen”.

The grim verdict is in a new report, No Stress III – The Flaws in the Bank of England (BoE)’s 2016 Stress Tests, published by the Adam Smith Institute today.

Worryingly, it says the BoE’s latest round of stress tests “drastically underestimates” the vulnerability of the banking system and risks to the UK economy.

It adds Britain’s banks remain highly leveraged and another 2007-08-scale financial shock could cause them to fail.

According to the ASI, “properly stringent” stress tests and market valuations of bank capital would have seen all major UK banks fail.

The institute argued that the BoE’s tests of financial strength are “worse than useless”, offering false comfort as lenders are herded into identical business models.

Kevin Dowd, author of the report and professor of finance and economics at Durham University, said: “The stress tests are about as useful as a cancer test that cannot detect cancer.

“They seek to demonstrate a financial resilience on the part of UK banks that simply isn’t there.

“It is disturbing that, 10 years on from Northern Rock, UK banks are even more leveraged than they were then. The biggest risk facing the UK banking system now is the Bank of England’s own complacency.”

According to the ASI, more accurate numbers based on real market value show banks’ leverage has actually increased by about half.

The report claims the sector is “still carrying large hidden losses”, adding: “The stress tests provide the public with false assurance about the financial health of their banks.”

Ben Southwood, Head of Research, ASI, said: “The Bank of England, understandably, wants to prepare for bad eventualities.

“But its definitions of risk are nonsensical. The stress tests are yet another incentive for banks to put all their eggs in one basket.

“Even if the Bank were right about risks, this would make crises less frequent but much, much worse.”

“The Bank of England, now with all its extra powers, should focus on improving the rules of the game, not micromanaging banks’ balance sheets.”

Northern Rock crashed in 2007 after the first run on a UK bank in more than a century. It became an early symbol of the financial crisis.