UK Finance stands by MCP credit guidance despite significant lower default results

UK Finance has reiterated its support of the UK Monetary Policy Committee (MPC) guidance on credit control actions which were sanctioned following the committee’s ‘stress test’ projections to analyse the UK economy in May.      

Updating its financial services members providing personal and business loans, UK Finance stated that ‘COVID-19 remains severe stress on banks and that the UK economy may be attenuating’.

Having reviewed the Bank of England (BoE) and Monetary Policy Committee (MPC) latest ‘Financial Stability Report (FSR)’, UK Finance revealed that UK GDP had only contracted by 5.5% to date in 2020 – a figure significantly below Spring’s dire projections of a 14% reduction in GDP output.

Further economic reprieve has seen the UK unemployment rate track currently at 7.5%, below its previous May estimate of 9-10%. Despite this, UK Finance has remained cautious over the BoE’s latest FSR results.

Writing to UK Finance members, Simon Hills Director for Prudential Policy emphasised that MCP’s May recommendations were best regarded as a ‘reverse stress test’, undertaken in light of unforeseen COVID-19 circumstances for all financial services institutions.

“A reverse stress test asks a different question, not ‘how bad could it get?’ based on a posited economic scenario but instead ‘how much worse would it have to be?” Hills states.

As a result of the ‘reverse stress test’, the MPC’s May projection of a combined £120 billion credit did not materialise, with the latest FSR report revising down forecasts to ‘less than £80 billion’, based on an improved economic outlook, with expected lower defaults on UK credit lending.

UK Finance has supported MCP’s May recommendation that UK Banks should reserve circa 5.2% of their capital to secure a rise in credit defaults, maintaining financial buffers to absorb any potential credit crisis.

Hills noted that UK banks and lending institutions should have been aware that the MPC’s stress test ‘reverses out two alternative pathways for the economy, either of which could generate £120 billion in credit losses’.

He added: “While it is comforting to know that UK banks can absorb further shocks before depleting all their capital buffers, reading the FSR reminds us that economic activity is the sum of a huge range of individual choices”

“Every member of society can play their part in ensuring that the Covid-19 reverse stress test scenarios do not become a reality. And the best way we can do that is by following government advice – staying alert, controlling the virus and saving lives.” UK Finance concludes closing its statement.