Banks face foreign investment shock in latest Bank of England stress tests

● Further scenario will raise interest rate towards 4% and see house prices plunge

Britain’s biggest lenders will have to prove they are able to withstand a sharp slowdown in foreign appetite for UK assets as part of the Bank of England’s toughest stress test scenario to date.

It comes amid concerns the UK has become particularly vulnerable to global investor sentiment after sterling collapsed and bond yields soared in the wake of the Brexit vote.

“As highlighted in recent financial stability reports, the United Kingdom’s large current account deficit creates a vulnerability to a reduction in foreign investor appetite for UK assets and increases in funding costs for real-economy borrowers,” the Bank said yesterday.

“The 2017 cyclical scenario incorporates a sudden increase in the rate of return investors demand for holding sterling assets and an associated fall in sterling.”

The Bank will for the first time put lenders through two stress scenarios, which will separately test their ability to withstand pressures of ultralow interest rates and rates rising towards 4 per cent.

The so-called “exploratory” scenario will incorporate “severe and synchronised” stress to both the British and global economy and financial markets, with weak growth, low interest rates, stagnant trade and cross-border banking activity.

It will also test whether lenders can face increased competition from smaller, challenger banks and further misconduct costs. The scenario will cover a seven-year period, with the results published in the fourth quarter of 2017.

The other scenario will raise interest rates towards 4 per cent and see house prices plunge 33 per cent in the UK, while a global and domestic recession sends economic growth rate spiralling by 4.7 per cent.

The annual stress test will examine the resilience of seven UK lending giants – Barclays, HSBC, Lloyds Banking Group, Nationwide, Royal Bank of Scotland, Santander UK and Standard Chartered.

RBS was last year forced to raise around £2 billion to boost its balance sheet after failing the Bank of England’s annual health check.

It is understood the main reason RBS failed the 2016 stress test was the threat of a huge fine for mis-selling of US mortgage securities, which some feared could climb as high as £12bn.

Barclays and Asian-focused player Standard Chartered also struggled in the test, but were deemed to have adequate plans in place and were not forced to take any further action.