The Bank of England Stress Tests show Misconduct has biggest negative Balance Sheet impact

By The Enforcd TeamThe Enforcd Team
Bank of England Stress Tests

The Bank of England has published the results of it’s stringent 2016 stress tests, which incorporated a synchronised UK and global recession with associated shocks to financial market prices, and an independent stress of misconduct costs.

The Report made for sobering reading, and extracts on misconduct follow.

“The 2016 stress test also incorporates stressed projections, generated by Bank staff, for potential misconduct costs, beyond those paid or provided for by the end of 2015. These stressed misconduct cost projections are not a central forecast of such costs. They are a simultaneous, but unrelated, stress alongside the macroeconomic stress and traded risk scenario incorporated in the 2016 test. There is a very high degree of uncertainty around any approach to quantifying misconduct cost risks facing UK banks. The stressed projections relate to known past misconduct issues, such as mis-selling of payment protection insurance and misconduct in wholesale markets. They have been calibrated by Bank staff to have a low likelihood of being exceeded. They are therefore, by design, much larger than the amounts that had already been provided for by banks at end-2015. However, partly because they relate only to known issues, they cannot be considered a ‘worst case’ scenario.’

The Bank found that in relation to misconduct:

“Stressed projections for misconduct costs beyond those already provided for at the end of 2015. Around £30 billion of these additional misconduct costs are projected to be realised by the end of 2017, reducing the aggregate CET1 ratio by 1.6 percentage points. This compares to an aggregate of around £40 billion paid and another £18 billion provided for by banks, but not yet used, over the period 2011–15.”

They also spoke about their qualitative review, and about Banks’ failure to develop new models:

“Qualitative review An important objective of the concurrent stress-testing framework is to support a continued improvement in banks’ own risk management and capital planning capabilities. On that basis, as in previous concurrent tests, the Bank also undertook a qualitative review of banks’ stress-testing capabilities. The PRA Board judged that banks in aggregate have made progress this year, but was disappointed that the rate of improvement has been slower and more uneven than expected. As set out in the Bank of England’s ‘Approach to stress testing the UK banking system’, the qualitative review will be considered in the Bank’s broader assessment of banks’ risk management and governance arrangements for the purpose of setting the PRA buffers and will continue to influence the intensity of supervision of individual banks. In order to raise standards in model development and management, the Bank plans to publish expectations against which banks’ modelling frameworks will be assessed. The Bank, through the Basel Committee’s Working Group on Stress Testing, is also collaborating with other regulators in the review of bank and supervisory stress-testing programmes and, as needed, will be developing further guidance to enhance these programmes.”

There have been a number of developments since the launch of the 2016 stress test. As well as news around fines relating to the mis-selling of US residential mortgage-backed securities, the Financial Conduct Authority announced in August that its proposed PPI time-bar will be delayed until end-June 2019. During the first three quarters of 2016 the major UK banks made around £6 billion of additional provisions for misconduct costs and fines. Bank staff have taken these developments and other news into account in calibrating the stressed projections for misconduct costs and fines included in this test.

Development of new models: The Bank expects banks to continue to enhance their ability to model the impact of the stress over time. The 2016 review found that development of new models and approaches had slowed in more established areas of risk modelling such as credit risk. Beyond these traditional disciplines, banks are yet to make significant progress in developing their modelling capability. For example, banks continue to rely largely on judgement-based approaches when projecting their revenues and costs. In order to raise standards in model development and management, the Bank plans to publish expectations against which banks’ modelling frameworks will be assessed. The Bank, through the Basel Committee’s Working Group on Stress Testing, is also collaborating with other regulators in the review of bank and supervisory stress-testing programmes and, as needed, will be developing further guidance to enhance these programmes.”

The following chart illustrates with clarity how misconduct and related fines and remediation has the capacity to have the greatest negative impact on a bank’s capital reserve – outweighing even a severe UK macroeconomic downturn.

Bank of England Stress Chart


Enforcd mentioned by Bank of England’s COO in Speech

By The Enforcd TeamThe Enforcd Team
Bank of England's COO

In a speech at Web Summit in Lisbon the Bank of England’s COO, Charlotte Hogg, gave an update on the work of the Bank’s FinTech Accelerator since its launch in June. Charlotte detailed the current work underway and the firms the Bank is engaging with, and made reference to Enforcd’s ‘proof of concepts’ during the speech.

She also announced that the window for applications for the next round is now open.

The FinTech Accelerator deploys innovative technologies on issues that matter to the Bank’s mission and operations. Working in partnership with FinTech firms the Bank is seeking to develop new approaches, build its understanding of these new technologies and in some way support development of the sector.

Commenting on the progress of the FinTech Accelerator since its launch in June and the completed proof of concepts, Charlotte said:

“We set up the Bank’s FinTech Accelerator in the Bank, launched in June this year, precisely to develop our practical experience of FinTech.  In the Accelerator, we seek to engage with a large number of FinTech firms and technologies, and to run a series of targeted, rapid proof of concepts (POCs) with a number of them.  All POCs are work on problems or challenges that are important to us, and the firms are carefully chosen through an open process based on our published criteria…Recent POCs have covered three main areas – data analytics, information security, and some work exploring distributed ledgers.”

Charlotte then announced the current POCs and the start-ups the Bank is working with:

“A recent addition to the FinTech Accelerator is a POC with BMLL Technologies that uses a machine learning platform, applied to historic limit order book data, to spot anomalies and facilitate the use of new tools in our analytical capabilities.  A second new POC, with Enforcd, uses an analytic platform designed specifically to share public information on regulatory enforcement action.

“We have also partnered with two firms – Anomali and ThreatConnect – that provide innovative technologies to collect, correlate, categorise and integrate cyber security intelligence data.”

Charlotte concluded by announcing that the window for the next round of applications is now open:

“New technologies present opportunities and risks and we need to assess both…as part of our mission to promote the public good.  Today, we’ve opened our next call for applications as we seek to further our research and work, continuing to bridge the gap between institution and innovation.”